NAV Loans: From Fund Finance to Investment Opportunity

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Dupe Adeyemo
Managing Director and Head—PE Fund & Manager Finance

Transcript

So when I think about managing a private equity fund, it’s really important to be able to manage the capital of the fund through its entire lifecycle. And NAV (net asset value) loans are a flexible tool that enables the private equity fund to hold on to assets when there’s additional value that can accrue to them, or to generate liquidity when appropriate to support those underlying companies.

NAV loans are a loan to a fund on the basis of the value of the investments they’ve made. So if a private equity fund has made investments in 10 different underlying companies, a NAV loan would be a loan against the value of the investments that they own.

If you’re managing a private equity fund, it’s really hard to forecast the amount of capital you’ll need during the entire lifecycle of a fund. So what a NAV loan does is enables a fund to borrow at a low LTV (loan-to-value) to make one additional investment. This enables the fund to, in many senses, have their cake and eat it as well by getting fully invested while still maintaining on-call capital to manage the uncertain times.

Imagine there’s a private equity fund that owns a business that sells a certain product and wants to vertically integrate and buy a business that helps it manufacture that product as well. A NAV loan could be used by borrowing at the fund level when the fund may not have the capital available to make an acquisition, use that money to inject it into one of their underlying companies when that company can use that capital to make that acquisition. It could allow the combined company to grow significantly as they realize synergies and create the profitability of the combined company.

We believe that NAV loans offer strong risk-adjusted returns if they’re appropriately structured. Well-structured NAV loans benefit from low LTV, meaning they have significant cushion against deterioration of value of the underlying assets. And they also offer diversification.

Combine this with the rate of return that you can earn on NAV loans, which currently for IG NAV loans that are rated BBB is around 350 basis points above what you can earn for IG corporate credit. It could be a significant and interesting asset for insurance companies. The fact that they can be investment-grade rated means that insurance companies hold them on their Schedule D as a rated instrument.

So we believe the NAV loan lending market’s going to grow substantially over the next couple of years, due to two fundamental reasons. One, if you think about the overall scale of private equity and the AUM that has been gathered by private equity funds, we think that’s a catalyst for growth. And two, as additional private equity sponsors are learning about NAV lending as a flexible tool, market adoption is increasing.

And when you combine the overall size of the market and increasing market adoption, we believe the NAV lending market’s going to continue to grow substantially in the next couple of years.

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The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.

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