Got Commitment Issues? This Private Credit Trend Isn’t for You.

As the private credit markets mature, some investors are looking to form longer-term or even permanent relationships with their fund managers, industry experts say.  

Low fixed-income yields, an aging population, and more experienced investors have resulted in an outgrowth of permanent, evergreen, and long-term fund structures in private credit. Private credit managers say that trend is likely to continue as the industry continues to grow.

The boom in private credit markets began after the Great Financial Crisis, when banks were no longer able to use their balance sheets to lend money. “Banks really pulled back from the business after the Great Financial Crisis,” said Michael Ardisson, chief operating officer and president at Medalist Partners, a private credit firm. 

As a result, the private credit market has grown “astronomically,” according to Emma Bewley, head of private debt and uncorrelated strategies at outsourced chief investment officer firm Partners Capital.  

“That disintermediation of the traditional banking model in the middle market lending has seen a huge increase in the amount of private capital in the space,” she added over Zoom. “With that you get innovation in how fund structures are set up.” 

In the wake of the Covid-19 outbreak, Ardisson said banks have once again pulled back from lending, creating an opening for private credit funds. Traditional lenders are “extremely cautious right now,” Ardisson said by phone. “They’re going vanilla, cookie-cutter, and squeaky clean.” 

Ardisson’s firm Medalist Partners is currently in the process of raising its third fund, which will have an evergreen structure. In the past, Ardisson and his team offered funds with three-year commitments and two-year harvest periods. But investors wanted the option to stay in the fund, Ardisson said. This third fund, which is targeting $500 million in commitments, will fill that need by allowing investors to stay in as long as they like. 

“There’s no liquidity mismatch to worry about and no forced redemption,” Ardisson said. “Investors can get paid out or just keep recycling.” 

Private credit firm Star Mountain Capital is similarly offering investors a long-term fund, according to the firm’s founder and chief executive officer Brett Hickey.  

“Investors said, ‘We want something that we can get our money deployed and keep it deployed but have some liquidity optionality for the future,’” Hickey said by phone Friday.  

In his view, the reason investors are looking for longer-term funds is three-fold. “I think investors are getting better at looking at data and they realized that trying to time the markets is extraordinarily difficult,” Hickey said. “People tend to pile in late and lose money, and then they tend to exit early.” 

Another driver behind these longer-term fund structures, Hickey say, is the need for institutions to serve aging populations. As pensions, insurance companies, and family offices prepare for a growing number of constituents to retire, they’re looking to ensure investment protection and yield.  

“Fixed income can be particularly attractive where you can hopefully protect your base capital where you don’t have to liquidate your portfolio,” Hickey said. 

Finally, Hickey said that longer lock-up periods can be a better fit for the underlying businesses that private credit funds invest in. These businesses want “flexible” capital that doesn’t require investors to “cut corners” to get liquidity on time, Hickey said. “The more long-dated your fund is, the more liquidity you have.”  

These fund structures are not without challenges, though. Ardisson said that when an evergreen fund decides to take in new money, the fund manager must assign a value to the assets in the portfolio. “Either you’re diluting someone or marking it too high,” he said. This drove Medalist’s decision to not allow new investors entry into the fund. 

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Bewley has a different take on the market. She said that she hasn’t seen a huge increase in the number of evergreen funds available for investment. However, she has seen more funds funds that deviate from private credit’s traditional three- to five-year investment period. According to Bewley, there has been an uptick in funds with shorter investment periods looking to exploit market dislocation.

“We believe there will be a number of opportunities coming in rescue lending where we can deploy capital. These loans will be refinanced quickly,” Bewley said. “That was one way that you saw managers looking to raise capital last year.”