Private fairness’s ‘layered leverage’ wants extra scrutiny, says PGIM chief | USAEMALL.com

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The chief executive of $1.3tn asset manager PGIM said he was concerned about the “layered leverage” that private equity firms are using to return cash to investors and urged regulators to insist on more transparency about complex forms of debt.

David Hunt said that as private equity groups struggle to exit investments, they have been using more complex and opaque forms of borrowing, such as leveraging up funds that own several already-indebted companies to finance payouts for their investors.

“Recently as exits have been difficult, I think they [buyout groups] needed to go back to financial leverage” to make money, Hunt told the Financial Times. “That can help you on the upside” but it could “really accelerate things on the downside”, he said. 

“It’s complicated enough that many people don’t understand it,” said Hunt, adding regulators should insist on more disclosure about such debt. “I think [introducing] some common way of understanding how much leverage is in the system is a good idea.”

Buyout groups have for decades loaded debt on to the balance sheets of the companies they buy in order to pay for their acquisition.

In recent years they have been increasingly using so-called net asset value loans, where a buyout fund borrows against the stakes it holds in those companies. The entities that manage those funds can also take on debt, representing another layer of leverage.

Groups including Vista Equity Partners, Carlyle and Hg Capital have used NAV loans to pay dividends.

The loans can also be used to support struggling companies within a fund. However, they are controversial because they add more leverage and cross-collateralise the fund’s investments, meaning that troubles with one company can spill over to others and put the entire fund’s returns at risk.

PGIM, the asset management arm of US insurer Prudential Financial, manages $319bn in private assets of which $206bn is in real estate and $103bn in private credit.

It owns private credit group Deerpath Capital and private equity specialist Montana Capital Partners, which focuses on “secondaries” deals.

Such deals include buying second-hand stakes in private equity funds and investing in transactions in which a private equity group sells a company to itself.

Hunt said that if interest rates keep falling, “maybe it will be fine”, but if not there could be problems with the rise of NAV loans.

His comments come after he raised the concerns last week at SuperReturn, a private equity industry conference in Singapore. “My advice to regulators is always follow the leverage,” he said at the event.

During the conference, investors discussed the slump in private equity returns since an era of cheap debt came to an end.

“That tide we’ve all been riding for the last decade and a half is out,” said Saima Rehman, who leads private equity and venture capital fund investments at the International Finance Corporation.

Ed Grefenstette, chief executive of Pittsburgh-based trust The Dietrich Foundation, which invests in private market funds, said that as deals have become more scarce, investors have been “forcing” buyout groups to sell companies too soon or borrow money in order to raise cash.

“It can really be to the detriment of the total portfolio returns”, said Grefenstette. “We’d much rather acknowledge the fact that this is a lumpy business . . . you just have to have the patience to get through that.”

Kutty Dutta, a managing director at HSBC’s alternative investments unit, said he was “cautious” about NAV loans and that they should not be “thrust on” investors. “The important thing is [investors] need to be consulted . . . their desires need to be factored into the decisions.” 

Some dealmakers struck an optimistic tone about interest rate cuts after the Federal Reserve cut rates by half a point.

“A 50 basis points cut on a levered asset is actually quite a meaningful cut because it’s . . . reducing their interest burden by a meaningful amount,” said Avnish Mehra, vice-chair of private equity at Everstone Capital.