Borrowing at the Fund Level Makes the Return Look Better
A subscription line lets a private fund invest before calling money from its investors. That improves the reported internal rate of return without improving a single underlying investment.
What the Facility Actually Is
A private equity or credit fund holds commitments from limited partners rather than cash. When it wants to buy something it issues a capital call, and investors wire money, typically within ten business days.
A subscription line of credit, also called a capital call facility, is a revolving loan to the fund secured not by the fund assets but by the uncalled commitments of its investors and the manager right to call them. The fund draws on the line to complete an acquisition immediately, and calls capital from investors later to repay it.
The credit quality is unusual and very strong. The lender is effectively underwriting the willingness and ability of a diversified group of institutional investors to honour legally binding commitments, not the performance of any underlying company. Losses have historically been extremely rare, which is why pricing is tight.
The Legitimate Reasons
The operational case is real and was the original purpose. Closing an acquisition on a fixed date requires certainty of funds, and waiting ten days for capital to arrive from dozens of investors is an execution risk in a competitive process.
Beyond speed, the facility reduces administrative burden by aggregating many small calls into fewer larger ones, smooths cash management for investors who would otherwise hold liquid assets against unpredictable calls, and handles foreign currency timing in cross border deals.
None of that is controversial. The controversy concerns duration.
The Arithmetic That Changed the Practice
Private fund performance is reported primarily as an internal rate of return, which is a time weighted measure. It depends on when investor money went out and when it came back.
If a fund draws on a credit line to buy a company, holds the line outstanding for a year, then calls capital, the investor money was deployed for one year less than the asset was held. The profit is unchanged. The measurement period is shorter. The IRR is therefore higher.
| No Subscription Line | Line Held Twelve Months | |
|---|---|---|
| Investor capital deployed | 100 | 100 |
| Proceeds returned | 200 | 200 |
| Multiple on invested capital | 2.0x | 2.0x |
| Years capital was outstanding | 5 | 4 |
| Reported internal rate of return | 14.9 percent | 18.9 percent |
The illustration is simplified and ignores the interest cost, which is real and reduces net proceeds slightly. The direction is not in doubt, and the effect grows the longer the line stays outstanding.
The multiple on invested capital does not move at all. Only the rate of return does, because only the rate of return cares what day the money left the investor account. Two funds reporting identical IRRs can have very different underlying performance if one used leverage at the fund level and the other did not.
Why This Matters Beyond Optics
Three consequences follow, and they are not merely presentational.
Comparability breaks. Ranking managers by IRR compares funds using facilities of different sizes and durations, which is not a comparison of investment skill. Institutional investors increasingly request performance reported both with and without the effect of the credit line, and the gap between those two figures is informative.
Carried interest can be accelerated. Most funds pay carry only after investors receive a preferred return, commonly around eight percent annually on drawn capital. Because the hurdle accrues on capital actually drawn, delaying the draw delays the accrual of the hurdle, which can move the manager past it sooner than it otherwise would.
Investors lose planning information. An investor holding liquid assets against expected capital calls needs to know when they are coming. Fewer, larger, less predictable calls make that harder, which is a genuine cost to the pension funds and endowments on the other side.
The Risk Nobody Priced for Years
The facility is secured by uncalled commitments, which means the security is the collective creditworthiness of the investor base. In a severe market dislocation, where several investors are simultaneously illiquid, that assumption gets tested.
Funds also began using longer dated and larger facilities, and in some cases net asset value facilities secured against the fund portfolio itself, which is genuinely different in character because it is leverage on the assets rather than a bridge to committed capital. Conflating the two is a mistake, and disclosure practices have improved partly because investors began insisting on the distinction.
What to Ask
For anyone evaluating a private fund: what is the maximum size of the facility relative to commitments, what is the maximum permitted duration of a drawing, is performance reported both gross and net of the facility effect, does the preferred return accrue from the date of the drawing or the date of the capital call, and is there any facility secured by portfolio assets rather than by commitments. Industry guidance now recommends disclosure on most of these, and the manager response to being asked is itself informative.
The Bottom Line
Subscription lines began as an operational convenience and became a performance instrument, because the industry headline metric is sensitive to a variable the manager controls. Nothing about the practice is improper when disclosed, and nothing about it improves the underlying investments. The correct response is not to object to the facilities but to look at the multiple on invested capital alongside the rate of return, since only one of those two numbers is indifferent to when the money left the investor.