Private Credit Investors and Alternative Investment Funds

Private Credit Investors and Alternative Investment Funds

Alternative Investment Funds (AIFs) provide an option to invest in different asset classes - such as venture capital, private credit, and hedge funds - primarily for Limited Partners (LPs) that are typically large pension funds, endowments, and family offices. The trend toward fund financing for AIFs, where a lender takes risk against the uncalled capital of the underlying investors, has become popular since it can help aid a fund's liquidity and boost the Internal Rate of Return (IRR).

Different Fund Financing Methods

Today, the typical fund-level financing options are subscription credit facilities, NAV facilities, and General Partner (GP)-sponsored solutions.

• Subscription Credit Facilities: This has traditionally been used for short-term bridge financing, which typically involves senior revolving facilities secured by the unfunded capital commitment of fund investors. Facilities are becoming larger, however, and the tenor[1] has become longer over the years.
• NAV Facilities: Instead of "looking up" to capital commitment, NAV facilities "look down" to fund assets. The facility is secured by equity in the portfolio holdings and is commonly used for acquisition finance and re-levering concentrated pools of investment. Since the COVID-19 pandemic, NAV facilities are also used to provide liquidity for working capital and to fund downstream obligations for portfolio investments.
• GP-sponsored Solutions: GPs are also exploring alternative solutions for sourcing capital at the fund level. This is often through preferred equity issuance to new investors who provide capital in exchange for priority distribution from some, or all, of a portfolio’s investments. It may also be through fund restructuring, which transfers a portfolio to a successor fund capitalized by new Investors and existing investors who rollover into the new fund.

The Need for Transparency

As the AIF market matures, more transparency is needed to address a number of issues:

• The AIF universe comprises mostly unrated entities and transactions, so there is not an assessment of credit risk readily available.   
• AIFs normally involve multiple LPs with different levels of creditworthiness, making it difficult to fully understand possible risks.
• There is the potential for regulators to begin to sharpen their focus on AIFs given concerns about how the use of leverage within the AIF sector may contribute to the build-up of systemic risk in the financial system.

The AIF Credit Assessment Scorecard is an essential tool to identify and manage potential default risks with fund portfolios, as well as understand the various factors affecting a fund’s creditworthiness. The AIF Scorecard includes:

• A consistent framework for calculating credit risk.
• The ability to identify default risk through quantitative and qualitative factors tailored for AIFs. Users can generate probability of default (PD) values for AIF portfolios and perform sensitivity analyses, scenario analyses, and stress tests.
• Credit scores that are designed to broadly align with S&P Global Ratings credit ratings,[2] supported by historical default data back to 1981.
• Technical documentation describing the analytical/statistical processes used to develop the underlying model, identifying the data used in construction, and providing testing performance results.
• Scorecard implementation and application training workshops.
• Ongoing analytical and operational support.

To learn more about the AIF Scorecard, visit our website here.