Private credit fund Management Fees – more than meets the eye

Wholesale private credit products offer investors access to unique and attractive investment opportunities not usually available to the retail investor market.

Because wholesale products don’t provide investors with the same consumer protection as retail funds, it’s important to review the offer document in full and seek advice if required.

This article seeks to raise investor awareness on the topic of private credit fund management fees.

Given the nature of debt returns, investors should understand their fund’s management fee structure to ensure there is an appropriate alignment of interest with the fund manager.

While low headline management fees can appear attractive, investors should review the information memorandum to determine the actual costs they face and any impact to their risk-reward proposition.

Consider a hypothetical fund manager with an investor-friendly management fee of 0.50 per cent.

Close review of the information memorandum discloses that the fund manager or its related entities may be entitled to additional compensation in the form of upfront establishment fees.

This hypothetical fund manager is presented with an opportunity to fund a 12-month interest-only facility in which the borrower has negotiated a gross 12.00 per cent annual rate (APR).

The manager submits a term sheet with an establishment fee of 2.00 per cent and an interest rate of 10.00 per cent, reflecting the agreed 12.00 per cent APR.

In this scenario investors receive a net return of 9.50 per cent comprising:

• 10.00 per cent gross interest earned: less

• 0.50 per cent management fee

The manager and its related entities earn a 2.50 per cent fee comprising:

• 2.00 per cent establishment fee; plus

• 0.50 per cent management fee

This scenario raises some points to consider, the most visible being the manager and its related entities earning an aggregate fee well in excess of the disclosed headline rate (2.50 per cent vs 0.50 per cent).

Less apparent but more significant is the impact on the investor’s underlying risk-reward proposition. While the loan is priced at 12.00 per cent to reflect underlying borrower risk, the investor has only a right to a 10.00 per cent interest income stream, with the 2.00 per cent establishment fee paid upfront to the manager or its related entities.

The author’s advice to prospective investors is to read documents in full, ask questions, and seek professional advice.

This article contains factual information only and is not intended to be general or personal financial advice and is for educational purposes only.