Liquidity Management in Private Credit: Unlocking Alpha Opportunities

In the quest for alpha within private credit markets, deal teams typically focus on maximizing spreads, incorporating original issue discounts (OIDs), negotiating covenants, and securing upfront fees. Once deals are closed, however, options for increasing returns seem limited, as the negotiated terms become fixed.

Yet, there’s a less explored avenue that holds potential: optimizing liquidity management. By strategically managing how and when we source capital, we can lower the cost of capital, increase net returns, and reduce cash drag on funds. This approach requires a tailored strategy that can vary by product type, from closed-ended funds with subscription lines to publicly traded business development companies (BDCs) with complex capital structures. However, the foundational principles remain consistent.

Strengthen the Treasury Function

One of the core tenets of a strong treasury function is a live view into all sources of liquidity.  This starts with a clear line of sight into all available cash accounts, dry powder, and leverage availability.  Managers must also understand the lead time required to source capital from these repositories.  Monitoring notice period for capital calls and leverage draws need to be anticipated to help ensure timely availability of capital without incurring any unnecessary cash drag to hurdle or financing costs.  Solutions like Hazel Tree and Kyriba to help centralize the treasury function and automate the tracking of our capital sources.  This allows straight through connectivity to our banking partners while ensuring operational scalability as we increase our fund count.

Plan for Capital Requirements

The second foundation is understanding what the disparate sources of capital requirements are for our investments.  At a minimum, firms must plan for new deal fundings, understanding what expected allocations are across our funds.  This allows for evaluation for each fund what are eligible sources of capital and organization of the capital sourcing strategy.  The more funds managed, the more complex the story.  Next, managers should be overlaying different asset and liability commitments they maintain.  This includes unfunded commitments, upcoming realizations, maturing unrealized FX P&L, and debt service payments amongst others.  Managers tend to implement solutions like Allvue or Sentry to help drive visibility for unfunded commitments as well as automation of allocation decisions, ensuring allocations are performed fairly while also respecting all investment guidelines that may constrain or eliminate a fund from allocation participation.

Automate Capital Sourcing Decisions

The final piece of the puzzle is automating the decisioning of where and when to source capital for each funding event.  Managers must be able to track your cost of capital for each source, notice period for advance funding requests, borrowing base guidelines for collateral constraints, and investor preference for capital pacing vs leverage utilization.  Each of these factors can then inform each funding event, observing capital reserve requirements, and produce a recommended funding plan by deal, by fund.  When integrated with a fund model, firms can also see the direct impact to their expected returns for the fund, and model out different funding scenarios to see exactly how each decision will impact their overall return.  Managers have leaned into solutions like Anaplan and Pigment to drive real time recommendations and decisioning to their funding process.

Unlock New Opportunities in Liquidity Management

In private credit, sustaining borrower relationships is essential, yet innovative firms are also optimizing operations to boost profitability and differentiate themselves in a competitive market. By focusing on liquidity management, managers can unlock new opportunities for alpha generation and enhance value for clients.

Contact us today to discover how refining your liquidity management can elevate your capital sourcing strategy and drive superior outcomes for your investments.