NAV financing: the champion of the fund finance market?
4 October 2024 - Michael Peterson and Shiraz Allidina, Managing Directors, Citco Capital Solutions Inc. discuss the rise of NAV financing, the ins and outs of its recent scrutiny, and what the future has in store.
What exactly is NAV financing?
Shiraz Allidina: A NAV facility is a loan to an alternative investment fund that is secured by the fund’s investments, which typically consist of private equity, venture capital (VC), infrastructure, credit, real estate or holdings in other investment funds.
Why have we seen such a surge in popularity?
Shiraz Allidina: It’s an alternative source of liquidity for funds, and in today’s environment, that’s a big deal. As central banks have tightened financial conditions, valuations for private equity or VC-backed companies have decreased, as has the volume of exits. A NAV facility serves as an alternative to a fire sale of assets, providing liquidity for funds at a reasonable cost. Moreover, these facilities have been an important source of financing, allowing funds to weather exogenous shocks, such as the pandemic and last year’s US regional banking crisis.
We have seen clients use these facilities defensively, protecting existing investments undergoing stress. We have also seen clients seeking to capitalize on a lucrative follow-on opportunity, using NAV facility proceeds to make investments that improve overall fund returns. At Citco, we’ve seen a 30% compound annual growth in the usage of NAV facilities by clients between 2019–2023, highlighting the growing popularity in this product.
What are your thoughts on the latest criticism of NAV loans?
Michael Peterson: There have been calls from industry spokespeople for heightened disclosure around how NAV facilities are used. And we agree with this – transparency is a good thing. Some worry that NAV facilities are used to fund distributions to LPs. However, Citco data shows that fewer than 15% of NAV facilities have been used to fund distributions to investors. The remaining 85% are used for follow-on investments, to generate liquidity as an alternative to secondary sales, and to support fund and deal expenses.
In addition to the lack of evidence around misuse, the funds launched over the past five years contain provisions whereby the use of NAV facilities must be made clear to LPs for their express approval. Moreover, regardless of the use case, provided there is disclosure and agreement from stakeholders, we believe NAV loans are an innovation which can increase financial stability, acting as a safety valve for alternative funds, allowing them to generate liquidity without selling assets at inopportune values.
So, what can we expect to see down the line? And is NAV financing here to stay?
Michael Peterson: NAV financing was originally developed in Europe, and the region’s use has been the main driver of its prominence to date. Looking forward, we expect increased recognition and utilization in the US – and aligned with this growth, we should also see new lenders entering the market. We welcome a bigger NAV lending marketplace: continuing adoption will improve systemic stability and support growth of the alternative investment landscape.
This article was originally published in Preqin