Michael Howard does not seem like a man who is easily upset. The softly spoken Scot, who heads Prudential Portfolio Management Group’s alternatives programme, does not even get fired up by fees.

Does he, for example, think it is wrong that investors pay management fees on committed, rather than invested capital? It is an often-raised bone of contention among other limited partners.

“It’s a good question,” he says, and after a short pause concludes this issue is not something he has strong views on. “It all comes out in the J-curve and the IRR at the end of the day.”

When he does sound something like a note of concern, it is on the use of subscription credit lines.

“If people are using credit facilities for a long period of time, and you are paying fees on committed capital… you could argue that is a double whammy”

“If people are using credit facilities for a long period of time, and you are paying fees on committed capital… you could argue that is a double whammy.”

Howard is responsible for a portfolio of £5 billion ($5.7 billion; €5.6 billion) split across private equity, infrastructure, hedge funds and other niche strategies. Across both infrastructure and private equity, Howard says his teams have seen terms “creeping on” when it comes to how long credit facilities can be used for, from three to six months, to between 12 to 18.

“When the facility appears to be used to deliberately lever the fund, it is going beyond the reason for having it in the first place,” he says.

Howard says his teams, when going through legal and operational due diligence – “through the LPA with a fine-toothed comb” – want to understand why they are using a credit facility and under what circumstances. “We will generally try to challenge [managers] saying ‘Look, do you need this for that length of time? What you have just described to us requires a facility for six months; why have 18 on your prospectus?’”

And does it make a difference?

“We get some wins, and we get some pushback and we just have to make a commercial decision,” Howard concludes.

The issue Howard has with prolonged use of credit facilities is the problem it presents to investors regarding capital allocation. 

“If you are collecting all the expenses and then clearing it off in three months’ time, then that is fine,” he says referring to what might be considered the more conventional use of a credit line. “If there is a long period of leverage in there, then that is an issue, because it means we will be underweight [against] our target and have to make a decision as to where we put that money that should have been invested in private equity.”

“Listed private equity?” I ask naively.

“Then you have two exposures,” Howard replies. “You are introducing more leverage into the portfolio. If you redeploy it elsewhere then your programme is levered… which is great when everything is going up.”

Capital left in cash – as it needs to be – earns an effective negative return based on the costs of the credit facility. I ask whether this is a genuine problem for PPMG as an investor or just a concern for Howard that the wider LP community may be encouraged to introduce additional leverage into their portfolios.

“I guess it’s just not the free lunch that people think it is,” he responds.