I often say the US$1 trillion fund finance market is the biggest asset class you've never heard of [1]. It’s obscure, even for the institutional investors who may be familiar with private markets. 

That’s a shame because ‘sub-line’ loans – one corner of the fund finance world – can deliver investors an extra 2 percentage points without taking on additional credit risk. They also offer a stable investment-grade asset with low correlation to other asset classes, even with other private market assets.

That’s nothing to sniff at in this uncertain world, amid almost daily shocks coming from the US, shaky stock markets and bond investors looking for clarity on the direction of inflation and interest rates.

Understanding ‘sub-lines’

Subscription-line facilities are a type of financing used by private market funds. These include private equity, private credit, infrastructure and real estate funds. 

They are essentially short-term loans which allow the managers of these funds to quickly access cash to make investments without having to call on capital commitments from investors straight away.

Lenders are usually banks. But some asset managers – including ourselves – have developed the expertise to make these loans for the benefit of our own clients – such as insurers, pension schemes and sovereign wealth funds. 

A sub-line loan can yield between 60 basis points (bp) to some 200bp more than comparable debt of the same tenor and risk that’s traded publicly. A basis point is 0.01 percentage point (so 200bp is 2 percentage points).       

Sub-lines are considered low risk. They are ‘senior’ loans secured against the uncalled investor commitments in a fund – a diversified collateral pool that over time has proven to be a low default risk.

Why borrowers pay more

Borrowers pay more for two reasons:

Middle market sweet spot 

The best opportunities right now are found in the ‘middle market’. This is where sub-line loans are made to ‘sponsors’ who invest in ‘middle-market’ companies with annual revenues that range between US$10 million and US$1 billion. 

These sponsors are also usually smaller than the household names (such as Apollo, KKR and Blackstone) but are still high-quality borrowers with great track records.

The key thing to understand is that the risk can be the same as lending to the big names. But there isn’t as much competition to lend to these smaller borrowers, so loan pricing can still look attractive for lenders.    

By moving into the middle market, we’ve found that lenders can receive as much as 50bp more than servicing the biggest borrowers, who can use their size to secure cheaper loans.

But why now? 

Getting price data for private markets isn’t easy. That said, based on our own experience, illiquidity premia are at very attractive levels compared to the historical average. 

For fund finance in general, the average yield spread – or difference – between comparable private and public market debt was some 94bp during the six-year period to end-2024. Last year, this spread reached 173bp on certain transactions [2].

The absolute return for a sub-line investor can be between 185bp and 300bp more than floating-rate benchmarks including the Sterling Overnight Index Average (SONIA), the Secured Overnight Financing Rate (SOFR) and the Euro Interbank Offered Rate (Euribor). 

As a rough guide, SOFR – a gauge of the cost of borrowing US dollars overnight – was 4.34% on March 28. Adding a conservative 185bp to this translates into a return of more than 6%.  

Final thoughts

According to industry reports, the annual demand for fund finance exceeds US$600 billion, and this figure is expected to grow as private market fund sizes continue to increase.

Sub-line facilities are an important part of the world of fund financing – offering institutional investors an attractive combination of higher yields for the same level of credit risk, stable income streams and diversification benefits.