QFIP-159: Private Debt Fund Returns

Question 1

Describe different private debt investment strategies.

Answer 1

Direct lending - practice of non-bank lenders extending loans to small and
medium-sized businesses in return for debt securities

Distressed debt lending - debt investing to companies that have filed for
bankruptcy or have a significant chance of filing for bankruptcy in the near future

Mezzanine lending - related to investments in debt subordinated to the primary
debt issuance and senior to equity positions

Special situations - distressed and mezzanine lending, where the loan decision
or grade is defined by criteria other than underlying company fundamentals

Venture debt - lending to venture capital-backed companies by a specialized
financier to fund working capital or expenses

Question 2

State the roles of the GP in PD transactions.

Answer 2

Roles of the GP in PD transactions:

Selection of attractive credit opportunities

Negotiation and execution of lending contracts

Active monitoring of investments and investee companies

Advisory roles

Renegotiation of lending agreements in case of covenant breaches

Execution of credit workouts

Realization of secondary market transactions

Question 3

Describe the steps of the life cycle of a private debt fund.

Answer 3

1. Fundraising Period - investors commit capital, GP tasked with deal sourcing,
   deal evaluation and executing first investments
2. Investment Period - typically lasts 2-4 years from the final closing in the
   fundraising period, GP may recycle proceeds of early exits during this time
3. Harvesting Period - GP exits investments and distributes all proceeds,
   net-of-fees, to LPs

Question 4

Describe the meaning of “ex ante” and “ex post” in terms of private debt investing

Answer 4

Ex ante refers to the period before the first cash contribution from LPs
Ÿ Inception of a fund is when the first capital contribution of LPs is received
Ÿ Ex ante market conditions are publicly available and observable to all market
participants when deciding to commit to the fund
Ÿ Economic conditions prevalent in the early life of a fund may significantly impact
lifetime fund performance

Ex post refers to the period after the first cash contribution from LPs
Ÿ Ex post market movements are not publicly known ex ante
Ÿ Can assess the skill of a GP to anticipate and respond to private market-timing
signals
Ÿ Typical fund allocates and renegotiates a substantial part of its assets during this
period

Question 5

Describe how to use IRR to measure PD fund performance.

Answer 5

Cash flow data can be used to calculate IRR to measure performance

Cash flows of investments from LPs are called “contributions” and denoted by C

Distributions to LPs are denoted by D

Suppose there are N total funds, and i denotes the fund where i 1, 2, 3, . . . ,N

Inception date is denoted by t0i , last available cash flow is at time Ti

IRR of fund i is calculated by solving for the IRRi that gives a PV of net cash flows
of 0
¸Ti
tt0i
Dit Cit
p1 􀀀 IRRi qtt0i
0

Question 6

Describe how to use Public Market Equivalent (PME) to measure PD fund
performance.

Answer 6

PME is computed as a ratio, and compares the PV of cash invested by LPs with
the cash returned to LPs:
Public Market Equivalent (PME)
PV Distributions
PV Contributions

PV is computed using the realized market return Rms from the benchmark index
Ÿ The notation this reading uses is that subscript m denotes the market return, and s
denotes the time subscript
Ÿ PME adjusts for risks spanned by the benchmark return by discounting with Rms

Interpretation
Ÿ Fund with a PME ¡ 1: Outperformed the benchmark index over its lifetime
Ÿ Fund with a PME 1: Underperformed the benchmark index over its lifetime

Question 7

Describe how to use net multiples to measure PD fund performance.

Answer 7

Net Multiple
Distribution /
Contributions

Question 8

Describe persistence. Explain whether PD fund exhibit persistence.

Answer 8

Persistence - exists if some GPs possess specific skills that allow them
consistently to perform better than their peers

Multivariate analyses suggest that a GP’s prior fund performance is a significant
and economically important predictor of future fund performance

These results were mostly seen for mature funds with at least 75% of capital
called; persistence of early-stage funds should be viewed with more caution

Question 9

Summarize ex-ante and ex-post market condition impacts on PD fund performance.

Answer 9

The table below summarizes which movements have a favorable impact on fund
performance:
Metric Ex Ante Ex Post
TED Spread Lower Lower
Credit Spread Higher Higher
VIX Higher Lower
Only significant for net multiples regression