Week of July 29, 2024

Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation

At the U.S. Federal Reserve’s meeting this week, there was no rate cut. But in its statement the Fed was very clear that it was shifting from being “highly attentive to inflation risks” to now becoming “attentive to the risks to both sides of its dual mandate”, with Fed Chairman Jerome Powell noting that the “unemployment rate has moved up.” In the past he had just enthusiastically applauded how low it was. All of this continues to signal that the Fed will likely cut rates in September.?

Does this shift breed concern that unemployment is about to accelerate? At his follow up press conference, Powell emphasized that he is being attentive but still sees the labor market as strong – similar to where it was pre-pandemic and not likely a source of undue inflation. In other words, he views the labor market as normalizing. And if inflation continues to cool, then a rate cut in September would be an appropriate step in resetting the economy on a sustainable growth path.

Sources: Bloomberg, Financial Times 2024.

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Andrew Kleeman , Senior Managing Director, Co-Head of Private Fixed Income

Net asset value (NAV) loans within the investment grade private debt market continue to garner significant interest from investors, and therefore merit a closer look. NAV loans are primarily used by private asset managers seeking to optimize liquidity and returns; the facilities are typically secured by the cash flows and value of the underlying assets in a fund. When structured appropriately, NAV loans offer the potential benefits of low loan-to-value ratios, diversified collateral bases, covenants to monitor and preserve the quality of the collateral and cash sweeps to appropriately de-lever as the collateral is monetized. From the perspective of borrowers, NAV loans allow asset managers to access an accretive financing solution to fund incremental portfolio investments and enhance returns without a significant increase in risk.

Although the market for NAV facilities is still small, with some estimates sizing the market at US$100 billion, it has experienced strong growth over the past few years due to increasing interest from both lenders and borrowers. One notable observation, however, is that this growth has experienced friction in 2024, predominantly in the form of some limited partners (LPs) resisting the use of NAV facilities in the funds (the borrowers) they are invested in. This has prompted general partners (GPs) to have a more substantive conversation with their LPs about NAV facilities and provide greater transparency with respect to the impact of these facilities on the risk/return profile of the fund.

Ultimately, we believe some level of tension between GPs and LPs will result in more prudent use of NAV facilities by GPs and wider acceptance by LPs. Based on market surveys, there is already some evidence of this in the form of more nuanced LP views as opposed to blanket disapproval. In a recent survey published by Rede Partners, only 38% of the surveyed LPs had a positive or neutral view of NAV loans used to fund distributions. However, 86% had a positive or neutral view of NAV loans used to fund add-on acquisitions. Over the next few quarters, as LPs and GPs continue to discuss the best uses of NAV facilities, we expect growth to remain somewhat slower. In the long term, however, we believe it is probable that NAV facilities may become nearly as ubiquitous as subscription lines.

Sources: Private Equity International, Rede Partners, 2024.

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Market insights are based on individual portfolio manager opinions and market observations. These are observations only and are not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not?constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information posted here.

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