Key Takeaways

  • Institutional LP sales carry an implicit cost of capital near 15%, driven by secondary market discounts and forfeited upside.
  • Preferred equity lowers cost of capital to roughly 10% without requiring bank covenants or formal credit ratings.
  • NAV loans price inside 10% but restrict sponsors to five-to-six-year maturities and strict collateral screens.
  • StepStone Group partner John Kettnich reports that CFOs deliver lower capital costs, longer maturities, and roughly twice the loan-to-value ratio of NAV loans.
  • Adrian Millan organizes these choices through PJT's Liquidity Cost-of-Capital Hierarchy, leading institutions to dual-track structured options alongside outright sales.

The PJT's Liquidity Cost-of-Capital Hierarchy

Adrian Millan outlines the baseline return hurdles: “If we take some break points, if we say that the LP market is at a 15% cost to capital plus or minus, the pref market is at maybe a 10% cost to capital, or low double digits to maybe high single digits, and then the NAV loan and CFO market all in, depending on LTV, is gonna be inside of that.”

  • Traditional Outright LP Sale (~15% Cost of Capital): Investor executes an outright sale of fund stakes at market pricing. Highest implicit cost of capital due to secondary discounts and complete forfeiture of future asset appreciation; best suited for mature assets with low single-digit go-forward return potential or situations demanding a clean administrative break.
  • Preferred Equity (~10% Cost of Capital): Specialist investors provide pooled equity capital in exchange for priority return distributions inside traditional secondary return targets (low double digits to high single digits). Useful for assets with uneven distribution profiles where credit rating or bank covenants are impractical.
  • NAV Lending (<10% Cost of Capital, Constrained Flexibility): Bank-syndicated debt secured against the portfolio net asset value. Provides low-cost capital but is typically restricted to 5-6 year durations and conservative collateral packages with lower LTV ratios.
  • Collateralized Fund Obligations (CFOs) (Lowest Cost of Capital, Max LTV): Rated debt tranches sold to institutional and insurance investors against a curated, cash-flowing private fund portfolio while the LP retains the residual equity. Unlocks up to twice the LTV of NAV loans with longer terms, provided the portfolio meets scale ($500M+) and rating agency criteria.

John Kettnich contrasts CFOs with standard bank debt: “If you just look at a CFO versus a NAV financing, you're gonna likely end up with a lower cost of capital for a CFO transaction. You're gonna end up with, to Adrian's point, for a duration, a term perspective, a more attractive mix of debt structure. You're also going to end up with the ability to probably have, I would argue almost twice as high of an LTV ratio.”

Millan highlights bank debt limits: “The NAV loan market is typically constrained because it's much shorter duration, meaning five-ish, maybe six years at maximum, and it is also much more stingy about the assets that are allowed to be included in the collateral package.”

With trade-offs across every option, Millan sees clients running parallel paths: “There isn't a decision tree that says, 'For this portfolio, the best solution is this.' It really goes to, there's gonna be trade-offs with each, and I think that that's why oftentimes a lot of the clients that we're bringing to market with maybe a traditional LP portfolio sale also want to run a dual track process for one of these partial liquidity solutions.”

When This Works (and When It Doesn't)

This framework applies when an institutional LP benchmarks liquidity options against expected portfolio returns. If underlying assets project returns above 12% to 15%, an outright secondary sale surrenders too much upside through discounts. Cheaper debt or preferred equity lets the institution unlock cash while retaining future gains.

The approach breaks down without scale or predictable cash flows. A CFO requires an asset base typically exceeding $500 million, plus credit ratings to support rated tranches. Smaller portfolios cannot absorb the overhead. NAV loans also impose strict covenants and short maturities; if fund distributions stall past five years, refinancing risk spikes. Outright sales remain the sensible choice when an institution seeks a clean break on mature vintages with low return outlooks.

Why It Matters

Sluggish distributions have turned secondary transactions into balance-sheet financing exercises rather than routine portfolio rebalancing. Allocators now price fund debt against market yields to keep private market gains intact. This shift signals that rated securitizations and insurance capital are becoming permanent fixtures in institutional liquidity management.