How significant an impact do subscription lines of credit, recycling provisions and deployment pacing have on interim valuations?
“Interim performance can be impacted by lots of different factors, including the use of subscription lines and how quickly capital is deployed. That means the perception of performance at any given time can be manipulated. To mitigate that risk, LPs need to delve into how aggressively subscription lines have been used, for example, which is increasingly easy to do as reporting standards have improved.
“Today, GPs commonly report both levered and unlevered performance. Sophisticated LPs will also look at individual deals to understand what is going on at the asset level rather than relying on aggregate multiples. However, as private markets funds are increasingly offered to retail investors who may not have the sophistication to unpack precisely how performance metrics are calculated, there is a risk that these manipulations could mislead them.”
Gregory Brown
“All three factors can affect interim valuations, although subscription lines probably have the greatest impact on observable fund-level performance. Knowing that, we always look at unlevered fund-level returns. In fact, we request deal-by-deal unlevered cash flows and compute unlevered fund-level returns ourselves, which illuminates the impact of sub-line financing. That means we can assess how much of reported IRR is due to underlying deal performance and how much is due to fund leverage.
“That said, while we can neutralise the effects of sub lines when evaluating a single fund’s performance, making comparisons to benchmarks can be tricky, because the benchmarks themselves are opaque. Of course, LPs are at least partly to blame for the increased use in sub lines, as many are compensated based on IRRs rather than multiple on invested capital (MOIC).
“At the same time, the use of sub lines has become an arms race among GPs. If levered returns are reported in benchmarks, it is not surprising that GPs are becoming more aggressive users of sub lines to position themselves in the best light. This is why we evaluate not only IRR and MOIC, but also DPI, public market equivalent, and other performance metrics.”
Michael Barzyk