Private credit funds: How family offices can protect the downside

Structures: Open-ended, closed-ended, hybrid

• Open-ended (evergreen): Funds that permit periodic subscriptions and redemptions (e.g., quarterly or semi-annual), and often have net asset value (NAV)-based fees, gates, and lock-ups. These private credit funds should be expected to hold shorter-duration, tradeable, or refinance-able assets.
• Closed-ended: Funds that have commitment and capital call features, fixed investment and harvesting periods, and distributions upon realizations post-commitment period, with no redemption rights. These private credit funds are most commonly targeting illiquid assets such as originations with bespoke terms and workout potential.
• Hybrids: Funds that may combine features of open-ended and closed-ended funds, such as commitments and capital calls, combined with investor-specific commitment periods and periodic liquidity windows. These private credit funds are built for extreme flexibility, and the risks for an investor include over-estimating the level of liquidity they offer. Depending on the terms, actually exiting vehicles of this kind can take some time.

Key consideration

Depending on the nature of the private credit fund, consider whether the team has the right expertise to perform an informed review.
 

Leverage: Subscription lines, asset-level debt, NAV facilities – and cross-collateralization

Credit funds often carry fund-level or asset-level leverage:

• Subscription lines: Borrowings secured by investor commitments. Helpful for cash management.
• Asset-level leverage: Warehouse lines or term financing against loan pools, for example.
• NAV facilities: Facilities secured by portfolio NAV.

In all cases, investors should strive to understand the usage and likely covenants and consider whether limitations are appropriate. Further, where the sponsor has multiple products, consider the sponsor’s approach to cross-collateralization. If one product’s assets back another’s borrowings, risk can migrate.
 

Key consideration

Cross-collateralization across unrelated sleeves or vehicles can be a concern. Seek details of what steps the sponsor takes to address such risks.
 

Valuation

Illiquid credit instruments may not have screen prices, leaving investors to rely upon:

• The existence of a clear valuation policy, with notice to investors required in the event of material policy changes, and independent oversight through a committee or third-party agent for subjectively marked assets.
• Performance-based compensation on illiquid products tied to realized gains or at least multi-period, high-confidence marks, not transitory model outputs. In some cases, funded givebacks will provide additional support.
• Write-down/write-up discipline.

Key consideration

Where a fund will invest in liquid and illiquid credit, consider whether the performance-based compensation bases are appropriately segregated, and whether incentive on illiquid positions should be deferred until realization. Consider requiring quarterly valuation memos for material non-performers.
 

Conflicts: Origination platforms, syndication, and opportunity allocation

Private credit fund sponsors may originate loans through affiliates, syndicate deals across funds, or sell positions into co-invest pockets. Investors should look for:

• Clear and objective allocation policies, with documented, periodic oversight.
• Affiliate fee transparency, particularly origination/monitoring/special servicing fees.
• Cross-trade rules and processes, especially when affiliates retain junior tranches.

Liquidity tools

In evergreen credit funds, voluntary redemptions can be gated or subject to “fast-pay, slow-pay” mechanics. Understand how the sponsor has approached:

• Queue transparency: One’s place in line.
• In-kind redemption protections: Is there a right to make a cash election?
• Asset transfers to affiliates/managed structures to meet redemption obligations.
• Slow-pay features. These provisions allow sponsors to satisfy withdrawal requests by carving off the redeeming investor’s pro-rata slice of the portfolio and holding those positions in a segregated account until their realization. During that period, the investor remains exposed to performance risk, continues to bear fees and performance-based compensation, and may be subject to an ongoing obligation to meet follow-on capital calls in respect of those sequestered positions. While slow pay is a useful liquidity management tool and a protective feature for investors, investors should understand these items and consider seeking limits on the permissible duration of slow-pay treatment, clarity regarding any follow-on funding obligations, and enhanced reporting regarding the timing and path to ultimate distributions.

Key consideration

Consider pushing for a cap on how long slow pay can last, require clear disclosure of follow-on obligations, and insist on regular updates on the disposition of sequestered assets.
 

In investing in private credit funds, family office priorities can vary dramatically, depending on the nature and features of the applicable product. They may include negotiating limits on slow-pay withdrawals, clarity around the use of unfunded commitments post-withdrawal, restrictions on re-underwriting or recycling provisions, and enhanced reporting on portfolio company credit performance and default management.