“This is a very large and fast-evolving market,” said Richard Sehayek, Co-Head of Europe for Alternative Credit. “It is also increasingly shifting from banks to alternative credit players, largely because if you’re in need of a liquidity solution, alternative credit players have the ability to bring customized flexible solutions in scale.”
This provides abundant opportunities for institutional investors on both sides of the fund-financing equation, as private credit providers partner with traditional banks, insurers and other investors to meet the ever-growing liquidity needs of GPs and LPs.
Why Now?
Several systemic factors and trends are driving higher demand for liquidity in private markets. Over much of the past decade, private fund managers have returned capital to LPs at a historically low rate. Despite an uptick in the ratio of returned to invested capital in 2024, known as distributed to paid-in capital (DPI), and generally strong overall investment returns, private equity’s traditional exit paths to liquidity largely remain challenging in 2025.
Some of these trends are hard to miss. For example, sales of portfolio companies to larger sponsors have decreased, amid a tighter fundraising environment and higher cost of capital due to elevated interest rates. The market for initial public offerings remains subdued, especially for sponsor-backed offerings. Meanwhile, a less receptive regulatory environment in both the U.S. and Europe has slowed sales to strategic buyers.
“GPs and LPs also face other market pressures. Market volatility, particularly in public equities, has pushed some LPs to seek liquidity from private fund holdings to rebalance their overall portfolios so that they can meet strict asset-class allocation mandates. That has ratcheted up the pressure for GPs at older funds to return capital to LPs and raise capital for new funds. Yet those same GPs increasingly seek to maintain ownership over high-performing assets beyond their original fund lifetime, usually due to a desire to continue to create value from core “trophy” assets, said Kevin Alexander, Co-Head of Alternative Credit.
At the same time, plenty of uncommitted capital, or “dry powder,” still sits on the sidelines waiting for appealing opportunities. As traditional banks continue to retreat from investment spaces they once dominated, such as fund financing, due to tighter regulatory requirements and preference for lower-profile risks, alternative asset managers may be positioned to help bridge the supply-demand gap by partnering with traditional finance players, like banks and insurers, to cover the capital needs of investment funds and asset managers, such as private equity sponsors, private credit managers and hedge funds, among others.
Evolving Fund Finance Solutions
In recent years, fund financing has expanded to meet the needs of a more mature private investment industry. Here’s a look at some of the most prevalent types of fund-financing solutions:
- Subscription lines are short-term loans backed by as-yet uncalled LP capital commitments. GPs use these loans to finance acquisitions and manage other early-stage liquidity needs. They roll off as capital calls ramp up.
- Hybrid facilities are backed by a combination of uncalled LP capital and securitized assets. GPs of continuation vehicles that start with assets retained from a previous fund typically rely on hybrid facilities to reduce upfront called capital early in the investment period and to manage liquidity into the portfolio management stage.
- Net-asset-value facilities are collateralized either by the assets of a single fund, usually company stakes, or by a portfolio of LP interests, usually secondaries. The combined ~$225 billion NAV market allows GPs to support existing portfolio companies, make additional investments, and/or return capital to LPs without liquidating fund holdings.
- GP solutions, which are collateralized by management fees, balance sheet investments, carried interest and other GP assets, may go to fund various GP commitments, succession planning or dividends, usually during the later stages of the fund lifecycle.
Each of these solutions is customized to meet the needs of different borrowers at specific stages of their fund investment and management life cycle. “From a liquidity perspective, in alternative credit, we are focused on an alignment of interests with our clients,” said Alexander.
Partnering with Banks and Insurers
They also attract different profiles of investors. Banks and insurers, for example, have traditionally been core investors in subscription line facilities—an $850 billion market that still makes up the bulk of the fund financing space. Subscription lines can carry investment-grade credit ratings, based on structure and loan-to-value ratios, a lower-risk profile that appeals to well-regulated financial institutions, like banks, insurers and other risk-averse asset managers. Hybrid facilities, depending on their structure, can also be rated investment grade and draw the same types of investors. And, increasingly, insurers in particular are also investing in NAV facilities and looking at opportunities in the senior tranches of CLOs.
However, the commercial banking sector, which once met most of the liquidity demands of institutions, has fundamentally shifted in terms of business model and market role, largely because of regulatory pressure on capital requirements. “As they have adopted an originate-to-distribute model, banks today are in the moving business, not the storage business,” said Alexander, adding: “They are not an ultimate credit solutions provider or liquidity provider. That creates a gap in the market.”
“We’re in this ecosystem where the banks and the private credit providers are going to work together to provide liquidity to the market,” says Alexander.
He sees particular strength in the NAV credit market. “In 2024, we estimated that less than 3% of the industry has tapped the NAV credit market, while 83% of lenders had reported an increase in the number of NAV credit transaction opportunities over the past year,” he says, adding that the NAV market alone could double over the next two years.
“And that’s just one category. We think the other solution categories could offer similar, if not even better, growth opportunities.”
To read more, please find Ares’ Fund Finance White Paper here.
