ResearchJuly 25, 2023

Private Credit: Fees Down, Rates Ascend

Investors in the in-vogue asset class hope that rising yields will boost their take.

Reported by Larry Light

Institutions have been piling into private debt limited partnerships in hopes of fat yields derived from rising rates, a study from consulting firm Callan LLC found. In the meantime, these investors do get one benefit: Fees are on the way down.

Among asset allocators, private credit is the in thing. Its assets under management jumped to $1.2 trillion globally last year, from just $332 billion in 2010, Preqin research found. That total should hit $16.1 trillion in 2027, PitchBook estimated. Among U.S. and Canadian public pension plans, per Preqin, private credit claims 3.8% of portfolios.

Helping that trend are Federal Reserve-stoked interest rates—private credit is largely a floating rate asset class, thus benefiting from the Fed’s upward rate movement.

Callan surveyed 330 private credit partnerships that were launched between 2016 and last year’s third quarter, aiming to allow investors a peek into how this burgeoning asset class is doing as a whole.

About two-thirds of the assets in this asset class are devoted to direct lending, in which a private credit fund makes a loan to a business, typically for three years. The rest of private debt is devoted to lending strategies ranging from real assets to distressed companies.

With the expansion of private debt funds, the management fees raked in by the general partners (nowadays often a massive financial giant with a large private equity presence, on the order of Apollo Global Management) have dipped. Originally, the funds followed the PE model and charged 2% annually of assets under management. In recent years, that has descended to a median 1.15%, Callan reported.

The general partners’ take of the distribution—when loans are paid off or, before that, as interest payments are distributed to investors—has classically been 20%, following the PE paradigm. But over time, with more entrants into the private credit field, that has come down to about 15% (known as carried interest), by Callan’s reckoning.

The hurdle rate—the minimum return GPs must clear before helping themselves to the carried interest bonanza—has been between 6% and 7% in recent years, down from the 8% that had long prevailed before the 2008 financial crisis, the report stated. Many LPs argue, Callan noted, that the hurdle rate should be restored to 8%, in light of today’s higher interest rates.