Public plan sponsors, already facing an overheated market for private equity investments, have to contend with a new obstacle in evaluating private equity managers and putting their money to work: the increasing use of credit lines.

General partners (GPs) are increasingly turning to subscription credit lines, which use limited partners’ (LPs) capital commitments as collateral to secure a line of credit from a bank, to fund acquisitions and delay calling on partners’ commitments. The approach began as a short-term tactic that benefited LPs, by giving them more time to meet cash calls instead of forcing them to pony up on a “just in time” basis. But institutional investors say the tactic has been expanded to delay capital calls in a way that could
inflate a private equity fund’s internal rate of return (IRR), making it more difficult for investors to evaluate potential partners and potentially triggering carried interest fees that would not have been warranted if the GPs put their partners’ money to work in a more timely manner.

“It’s like a baseball player taking human growth hormone and steroids — it can make an average player look terrific in terms of home runs, batting average, and slugging percentage,” David Fann, president and CEO of TorreyCove, a private equity and real assets consultant, told MMR. “It can make a mediocre fund look terrific on an IRR basis.”

Pensions are already feeling crowded out of private equity, with soaring demand for funds managed by top general partners. Entry prices for assets remain high, and dry powder has reached record levels — $906bn according to Preqin’s latest quarterly report on private equity, making for a challenging environment for managers looking to put capital to work. Credit only makes their jobs tougher.

Read the full story: Overuse of credit adds to PE crunch for pension funds

Published by Money Management Report/Pageant Media.