Insights
Fund FinancingFund finance: an opportunity for local government pension schemes
Could fund finance be an attractive addition to your LGPS portfolio? Find out here.
Author
Shelley Morrison
Head of Fund Finance
Duration: 5 Mins
Date: 04 Dec 2025
As the number of local government pension schemes (LGPS) in a negative cashflow position has increased, the focus on balancing asset growth with income generation has sharpened.
Currently, the world’s largest banks dominate the market. But new banks are now entering at the syndication level due to the attractive returns available.
Indeed, given the increasingly large size of the finance facilities, a lead bank typically syndicates the facility across several other banks, reducing its risk exposure. This is because banks often have sector limits and counterparty risk limits to manage. Syndication can manage these.
However, because other banks represent direct competitors, lead banks are increasingly looking for non-traditional lenders to participate in their lending programmes. This is an opportunity for LGPS.
While many schemes can rely on gilt, corporate bond, equity and private credit exposures to generate stable income, persistent inflation has led to continued cashflow pressures despite record high funding levels.
Time to enhance income generation?
Given uncertain new contribution levels and maturing memberships, schemes are relying more heavily on investment income and liquidation of assets. Many are considering adjusting strategic asset allocations to enhance income generation from liquid portfolios. Meanwhile, schemes have also been reducing listed equity exposure in favour of illiquid private markets strategies.
Liquidity for capital calls
Schemes are also coming under growing pressure to increase long-term investment in the UK to boost economic growth. This in turn creates an added requirement to maintain liquidity for short-notice capital calls.
Selling equity growth assets to meet commitments can introduce market timing risk, whilst allocating to less volatile more liquid investments such as cash or cash-like investments reduces returns.
‘Laddering out’ liquid holdings
Funds considering how to ‘ladder out’ their liquid investment holdings to maximise returns and maintain cashflows, are looking for a solution other than cash, money market funds or longer dated structures such as asset-backed securities.
Enter fund finance, a specialist private credit category with the potential to help improve diversification, manage volatility, and enhance yield over cash.
Time to enhance income generation?
Given uncertain new contribution levels and maturing memberships, schemes are relying more heavily on investment income and liquidation of assets. Many are considering adjusting strategic asset allocations to enhance income generation from liquid portfolios. Meanwhile, schemes have also been reducing listed equity exposure in favour of illiquid private markets strategies.
Liquidity for capital calls
Schemes are also coming under growing pressure to increase long-term investment in the UK to boost economic growth. This in turn creates an added requirement to maintain liquidity for short-notice capital calls.
Selling equity growth assets to meet commitments can introduce market timing risk, whilst allocating to less volatile more liquid investments such as cash or cash-like investments reduces returns.
‘Laddering out’ liquid holdings
Funds considering how to ‘ladder out’ their liquid investment holdings to maximise returns and maintain cashflows, are looking for a solution other than cash, money market funds or longer dated structures such as asset-backed securities.
Enter fund finance, a specialist private credit category with the potential to help improve diversification, manage volatility, and enhance yield over cash.
What is fund finance?
Fund finance facilities are loans provided to private market funds including private equity, credit, infrastructure or real estate across various stages of their lifecycle. The market is often divided into two areas:
LP-backed or subscription line financing
Backed by first recourse to undrawn limited partner (LP) commitments. These are typically by blue-chip investors, including insurers, pension schemes and sovereign wealth funds.
NAV (net asset value)-backed
Secured by a diverse portfolio of underlying assets and cashflows of private market funds, typically at a later stage of their lifecycle.
Why fund finance?
There are several operational and financial reasons why these facilities may be beneficial to both investors and the manager/general partner of the fund. These include:
- Providing managers with capital to finance investment activity within a few days, rather than drawing capital from investors, which requires a much longer drawdown notice period
- Giving greater clarity of the timing of cash calls to help investors manage their own cashflows
- Allowing cash calls to be consolidated or batched to delay drawing down on investors, bridging the finance of a portfolio company
- Enhancing IRR (internal rate of return)-based returns by delaying drawdown from investors
What is the opportunity set?
The global opportunity set for fund finance is over US$1 trillion [1]. We expect this to increase significantly in the coming years as private market fund sizes grow.Currently, the world’s largest banks dominate the market. But new banks are now entering at the syndication level due to the attractive returns available.
Indeed, given the increasingly large size of the finance facilities, a lead bank typically syndicates the facility across several other banks, reducing its risk exposure. This is because banks often have sector limits and counterparty risk limits to manage. Syndication can manage these.
However, because other banks represent direct competitors, lead banks are increasingly looking for non-traditional lenders to participate in their lending programmes. This is an opportunity for LGPS.
Why is fund finance attractive for LGPS?
Fund finance can be well-suited to the financial objectives of LGPS, including capital-efficient investment. This is because fund financing has:- Attractive credit quality
- Short duration – maturity between one and five years
- Uncorrelated returns to public credit markets
- Low volatility and credit risk
- First ranking security over collateral providing strong structural protection
Fund finance strategies also have enhanced yield potential. LP-backed strategies can achieve returns of 185–300 basis points (bps) over a floating reference rate, and NAV-backed strategies can target 160–500 bps over a reference rate.
In addition, whereas NAV loans are typically around five years in tenor, subscription lines are short-term, often under two years, aligning well with schemes’ liquidity management and liability matching needs.
Subscription lines can be very attractive from a risk-adjusted return perspective, achieving attractive premium over cash-equivalents or public credit, without taking excess credit risk.
Private market fund managers usually want to work with fund finance lenders that can offer short notice and flexible funding across a range of optional currencies. This can be daunting for those not familiar with the legal documentation and the structure of funds.
The complexities that are embedded within the credit and fund documentation can also be a hurdle for many. Performing the required due diligence and credit underwriting on the private market fund manager’s track record, strategy and investor base can be challenging and time consuming. On top of this, there’s the ongoing cash management and monitoring of each loan. Investment managers can provide an efficient way for schemes to participate in the fund finance market.
It also helps if your fund finance manager is already conducting ongoing in-depth due diligence of private equity vehicles, managers and their investors. Access to lending programmes across all the dominant banks active in this market is also essential.
Investment managers with these contacts and skillsets are best-placed to provide local government pension schemes with different currency loans, as well as a range of tenors and pricing options to support their specific requirements.
This article was originally published in Room151, a UK local government finance news publication.
What is the benefit of subscription finance compared with NAV finance?
NAV finance is well established with many institutional investors viewing this as the default option in fund finance. However, subscription finance is well suited to schemes seeking stable, income-generating assets with enhanced credit risk diversification, lower default risk and lower levels of correlation to equity markets or other credit assets, compared to NAV loans.In addition, whereas NAV loans are typically around five years in tenor, subscription lines are short-term, often under two years, aligning well with schemes’ liquidity management and liability matching needs.
Subscription lines can be very attractive from a risk-adjusted return perspective, achieving attractive premium over cash-equivalents or public credit, without taking excess credit risk.
Why access fund finance via an experienced asset manager?
The lending market has generally been the preserve of the banks. But in recent years, stricter regulation has pushed banks to co-invest with private investors. And sourcing deals for private investors is a challenge.Private market fund managers usually want to work with fund finance lenders that can offer short notice and flexible funding across a range of optional currencies. This can be daunting for those not familiar with the legal documentation and the structure of funds.
The complexities that are embedded within the credit and fund documentation can also be a hurdle for many. Performing the required due diligence and credit underwriting on the private market fund manager’s track record, strategy and investor base can be challenging and time consuming. On top of this, there’s the ongoing cash management and monitoring of each loan. Investment managers can provide an efficient way for schemes to participate in the fund finance market.
What should schemes look for in a fund finance investment manager?
In our view, when choosing a fund finance investment manager, it’s prudent to consider those with broad capabilities, including credit and liquidity management, currency hedging and, of course, operational, legal and structuring expertise.It also helps if your fund finance manager is already conducting ongoing in-depth due diligence of private equity vehicles, managers and their investors. Access to lending programmes across all the dominant banks active in this market is also essential.
Investment managers with these contacts and skillsets are best-placed to provide local government pension schemes with different currency loans, as well as a range of tenors and pricing options to support their specific requirements.
Final thoughts…
Given scheme maturity, we believe now may be an opportune time to consider fund finance. An experienced asset manager can help you boost diversification, manage liquidity, match liabilities and add yield potential by investing in this specialist asset class.This article was originally published in Room151, a UK local government finance news publication.
- Preqin, February 2025
