Private credit fund Management Fees – more than meets the eye

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Credit Fund

Written by Patrick William from Rixon Capital

Private credit fund Management Fees – more than meets the eye

 

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

Wholesale investment fund documents place the onus on the investor to review the 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 interrogate their fund’s Management Fee structure to ensure there is an appropriate alignment of interest with the Fund Manager.

While low headline Management Fees are an easy lure, 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% p.a.

Close review of the Information Memorandum finds disclosures 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% annual percentage rate (APR).

The Fund Manager submits a term sheet with an establishment fee of 2.00% and an interest rate of 10.00%, reflecting the agreed 12.00% APR.

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

-       10.00% gross interest earned: less

-       0.50% Management Fee

The Fund Manager and its related entities earn a de facto 2.50% Management Fee comprising:

-       2.00% establishment fee; plus

-       0.50% Management Fee

This scenario raises several challenges, the most visible being the Fund Manager and its related entities earning an aggregate fee well in excess of the disclosed headline rate (2.50% vs 0.50%).

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

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