Calling all LPs!

Welcome back and thanks for joining me (John Bailey, Co-Founder at OneFund) for another edition of Capital Call.

The mission of Capital Call is to deliver concise, top-notch insights and updates from the private markets tailored to what matters for LPs. 

This week we will be looking at: 

• Interest Rates & Recession Watch: A Q3 Update

• Fundraising updates and VC/PE reports

• GP Perspectives from David Cahn & Henry McVey

Interest Rates & Recession Watch: A Q3 Update

Global interest rate regimes are currently at an inflection point, with central bankers unsure if the war on inflation is over - although it does appear to be abating. The US Federal Reserve kept rates on hold in its recent September meeting but left open the possibility of raising rates in the future. In this week’s newsletter, I’ll dive into the latest macro data provided by Bain, and highlight how GPs, portfolio companies, and especially LPs should think about positioning themselves in the current environment.

Inflation Declines, but Some Macro Headwinds Persist

US investors have been on high alert for a recession since June 2022, when the 10-year minus 2-year Treasury yield spread inverted and inflation peaked at an over 40-year high of 9.1%. Since then, the US has largely tamed rampant inflation, keeping inflation down to just 3% in June 2023 and rising to 3.7% now (although that is largely due to higher energy prices). In contrast, the Eurozone and UK have fared worse, with current inflation at 5.2% and 6.3%, respectively, but they have still kept inflation down from the record highs of 2022.

The resiliency of the US economy always amazes me - personally, I never bet against the US even when things look dire like they did last year.

The latest macro data appears optimistic, however, given current geopolitical turmoil and remaining uncertainty, portfolio companies should prepare for a wide variety of economic or political scenarios.

With Sustained Rates, NAV Loans Gain Further Traction

Due to the continued macro headwinds that have caused a near $5 trillion pile up in assets, GPs have flocked towards NAV loans where a fund’s investment assets are used as collateral to generate proceeds. They’ve been used to pay down debts of struggling portfolio companies but have also been increasingly used to pay out dividends or to finance acquisitions by portfolio companies. 

According to the FT, NAV loans are being used more “defensively’ as GPs manage rising interest rates and debt maturities coming up in 2024 and 2025. Avoiding exits at discounted valuations, GPs are using NAV loans to extend exit timelines and flexibility to lock-in higher IRRs. 

NAV loans can be a useful liquidity tool if used correctly, but LPs should be wary of GP’s reliance on them. To start, they typically carry interest rates between 10-13% which can significantly eat into fund returns. They also put the entire portfolio at risk in order to prop up a few underperforming assets. In the case of GPs using these loans to perform strategic investments, LPs should assess whether these investments will outperform the 10-13% interest cost. If NAV loans are used to return capital to fund participants, LPs must understand they are receiving distributions today at the cost of lowered returns upon fund exit and determine if near-term liquidity is preferable to higher future distributions.

Personally, NAV loans freak me out.

Updates from Across the Ecosystem

Fundraising

📈 J.P. Morgan Seeks $500m for recharged Secondaries Strategy

📈 Brookfield Raises $12 Billion for Flagship Private Equity Fund

📈 Warburg Pincus Racks up $17.3b for 14th Global PE Fund

Reports

🔬 Pitchbook: An LP’s Guide to Manager Selection

🔬 KKR: Finding Equilibrium in Public and Private Credit

🔬 McKinsey: U.S. Consumer Spending Trends

GP perspectives:

Jonny Fine (Head of Investment Grade Syndicate, Goldman Sachs)

Jonny Fine, who leads Goldman Sachs’ Investment Grade Syndicate team, is bullish on U.S. corporate performance weathering macro headwinds. He notes that the U.S. did a good job of issuing long-term debt at low rates and states, “When we had very low-interest rates, around 25% of all issuance in the US corporate bond market had a 20-year or longer maturity.”

This means very little debt will come due for refinancing at much higher rates, avoiding a potentially disastrous “cliff effect”. This cliff effect is also avoided on the consumer side as most households are now using 30-year fixed-rate mortgages, making them less sensitive to rate changes. The U.S. is uniquely insulated from rate-hike effects compared to other economies, providing a likely faster recovery to normal macro conditions.

Fine concludes he is optimistic about the U.S. economy over the next 12-24 months. If he is correct, it may trigger the rekindling of U.S. PE transaction activity that many anticipate.

Chamath Palihapitiya (CEO, Social Capital)

Though recent reports and analyses are bullish on economic recovery, especially in the U.S., Chamath brings up a strong counterpoint that may bring more macro headwinds. US Strategic Petroleum Reserves (SPR) are at their lowest point in history at just 17 days, compared to a historic average of 33 days, meaning the U.S. has weakened its ability to control oil prices.

Oil supply will further shrink with two active wars and a 1.5 million barrel production cut by OPEC, creating a high likelihood of oil prices spiking which then causes CPI to increase significantly. The Federal Reserve would then need to delay the expected rate-cutting cycle, possibly triggering a recession.

When experts mention investors should prepare for downside scenarios, these are the types of events that can happen. Though the general consensus is a normalizing macro environment, economies remain fragile and investors should prepare to underwrite a wider variety of scenarios than ever before.

That being said, I personally am less worried given that the US is the world’s largest producer of oil and can likely refill its reserves if needed relatively quickly.

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