As the buzz around rated note feeders grows, it is important for General Partners (GPs) to understand the benefits and nuances of the structures as they move from a niche to a broad offering. Rated note feeder funds rise to prominence has been led by insurance companies that are sensitive to ratings but also seek higher yields and to diversify into private funds. Regulatory pressure has deterred these types of investments in the past, but rated note feeder structures have provided a means for these investors to participate directly in private funds with favorable capital reserve requirements.
At the most basic level, rated note feeders act like a standard feeder fund by satisfying the unique needs of specific investors. The mechanics and administration of these vehicles, however, can greatly differ. Within a rated note feeder, investments are made by purchasing notes issued by the feeder. This investment generally includes a smaller equity commitment that provides substance to the note ratings. The feeder entity commits to a Limited Partner (LP) interest in the main fund and the fund’s assets support the bonds. The sponsor engages a ratings agency to rate the notes, which are often issued in multiple tranches to align with the investor’s needs and rating targets. The effect is a product that generates fixed income like cashflows and carries a lower risk-based capital factor than a direct equity investment.
The benefits are clear: investors maintain favorable regulatory capital treatment and gain the yield and diversification benefits of private funds. Fund sponsors gain access to a new source of capital in what has otherwise been a challenging fundraising environment for many managers. Sponsors keen to access this market segment must be prepared when fundraising as competition is growing. The first step is understanding the legal and structuring nuances to determine if a rated feeder fits the fund’s strategy (think private credit or cash flowing equity investments like secondaries). It is then prudent to move early to get ahead of long lead tasks to spin-up the structure, such as rating assignments and negotiating terms to ensure the interests of the feeder align with the broader LP population in the main fund. Once established, operations professionals and fund administration partners must understand the structure to create workflows that support the nuances of the rated note feeders. Key areas to consider include:
Bandwidth:
Treasury Management:
System Limitations:
Evolving Terms:
When looking to implement and manage rated note feeders, having an experienced and flexible team is important. Increased regulatory attention and fluid fund terms will exacerbate the need for professionals who can quickly adapt. Being prepared by understanding the characteristics of rated note feeders from the start will help firms establish procedures to successfully manage these vehicles from day one.
Please reach out to Patrick Costello or Stephen Trainor to further discuss this topic and to understand Petra’s experience working with private credit funds leveraging rated note feeder funds.
About the Authors
Patrick Costello is a director within Petra Funds Group’s private credit team. He has over 15 years of financial operations and private credit experience having worked at State Street before over a decade at Denham Capital Management, most recently as the VP of Finance.
Stephen Trainor is a senior manager within Petra Funds Group’s private credit team. He has over 10 years of experience in private credit accounting having worked at ALPS Fund Services, THL Credit/First Eagle Investment Management, and Manulife Capital Management before joining Petra.
