Lesson 23 of 25 · 7 min
What an exchange fund costs in liquidity and in time
The price is paid in years and in what a lender will count, rather than in a premium quoted per share.
The options in lessons 12 to 17 charge a premium that can be annualised. This structure charges almost nothing that looks like a premium and a great deal that does not appear as a price at all.
The collateral consequence is the sharpest of the four structures in this track, because units in a private pool are usually non-marginable: their advance rate is zero. A pledged pool of $4,180,000 holds one name at $1,900,000 with a 38 percent advance rate, giving $722,000, plus $2,280,000 of diversified collateral at 74 percent, giving $1,687,200. Lending value is $2,409,200, and a $1,300,000 balance gives loan to value of 54.0 percent.
Contribute the $1,900,000 name and the units count for nothing. Lending value falls to $1,687,200, so loan to value becomes $1,300,000 ÷ $1,687,200 = 77.1 percent. Concentration risk fell by roughly 97 percent on lesson 22's arithmetic, capacity fell by $722,000, and the units cannot be sold to cure a call for the length of the lock-up.
The time cost compounds that. A seven-year lock-up at an illustrative 0.85 percent annual fee costs $1,900,000 × 0.0085 = $16,150 a year, or $113,050 over the term before any growth. Early exit, where permitted, commonly returns the contributed shares rather than a basket — which reinstates the concentration and, if the position has appreciated, at a larger size than went in.
A structure with no premium is not a structure with no cost. Here the cost is denominated in years of illiquidity and in a lending value of zero.
Key terms
- Non-marginable asset
- An asset a lender assigns a zero advance rate, so it contributes nothing to lending value however much it is worth.
- Lock-up period
- The years during which units cannot be redeemed. It is the period in which the holding cannot be used to meet any demand for cash.
- Early exit
- Leaving before the lock-up ends, where the terms allow it. It commonly returns the original shares rather than a diversified basket.
Worked example
Concentration down, capacity to zero
Pledged pool $4,180,000: one name at $1,900,000 with a 38% advance rate, plus $2,280,000 of diversified collateral at 74%. Balance $1,300,000. The name is contributed to a fund whose units carry a 0% advance rate. Illustrative figures.
- Lending value before
- $2,409,200
- Loan to value before
- 54.0%
- Lending value of the units
- $0
- Lending value after
- $1,687,200
- Loan to value after
- 77.1%
- Fees over a seven-year lock-up
- $113,050
$722,000 + $1,687,200.
$1,300,000 ÷ $2,409,200.
Non-marginable.
$1,300,000 ÷ $1,687,200.
$1,900,000 × 0.0085 × 7, before growth.
The single-name risk was largely removed and $722,000 of capacity went with it, for seven years, with no cash raised at any point.
Check yourself
A pledged holding worth $860,000 at a 35 percent advance rate is contributed to an exchange fund whose units are non-marginable. Your other collateral has $610,000 of lending value and your balance is $540,000. What happens to loan to value?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.