The figure is higher for the Arizona State Retirement System, which paid $60.2m in management fees (triple what it pays for real estate, double what it pays for private equity) and $70.8m in performance and incentive fees (more than triple the equivalent for PE) in the fiscal year beginning July 1.

Those numbers reflect a few broadly known truths: that private credit has got more popular since the pandemic, that rising interest rates have attracted LPs to the asset class, and that private equity has suffered as a result. 

Dig a little deeper, though, and there’s another interesting dynamic driving this higher fee outlay: more and more private credit firms are bringing formerly outsourced functions like loan servicing in-house, and charging those costs back to investors. 

For people who’ve been in finance for long enough, the hype around private credit is kind of hilarious — because ultimately it’s the same thing banks used to do, with slightly different branding and less regulation. 

As one of our sources pointed out, the fact that private credit firms are charging servicing and origination costs back to LPs is exactly what the banks used to do. Back to the future!

This dynamic may become more prevalent in the years to come, as many consider the future of private credit to be asset-based lending. 

Again, lending against assets is nothing new to the bankers that have been peddling ABS for decades. So this ‘hot new asset class’ is also quite retrograde. It’s also fairly complex, and often involves higher servicing and origination costs — so that could mean higher charge-backs for LPs. 

Thirsty

Last week we spoke about growing liquidity in the hitherto famously illiquid private credit market. LPs are trading stakes in funds with greater frequency, and firms are launching public BDCs and other types of investment vehicles that are designed to lure retail investors. 

A quick disclaimer/explainer for the uninitiated: this is fund-level liquidity, as opposed to asset-level liquidity. There are plenty of efforts underway to grow the secondary market for individual private credit loans, but this is very different to trading stakes in a fund or buying stock in a public BDC.

One of the ways in which asset-level liquidity in private credit is different to fund-level liquidity is that it is a lot harder to find. Several firms, including big banks like JP Morgan and Goldman Sachs, are trying to boost secondary liquidity of private credit loans, but from what our sources tell us, this has proved to be a challenging venture so far.

It’s like water in the desert: you need to be very persistent or very lucky to find it, and once you have, there aren’t many people around to share it with.

Speaking of secondary liquidity, a new fund from Charlesbank Capital Partners caught our eye this week. The firm’s Credit Opportunities Fund III closed a few days ago, sized at $1.5bn.

The fund will invest in public and private performing credit, special situations and distressed opportunities, focused on US middle-market companies with an EBITDA range around $75m-$100m. It’s a fairly flexible mandate.

“We see a lot of high quality US middle-market companies with debt that might be trading at 70-80 cents on the dollar in the secondary market, or they’re issuing new debt at very attractive prices, or there's a company that may be in distress that still has value,” said Sandor Hau, a managing director at Charlesbank Capital Partners, in an interview with 9fin. 

A big part of that strategy is buying individual private credit loans at a discount. Hau says that comprises about 40% of the strategy’s investment activity, while the other 60% of activity comes from new originations. 

Getting 40% of your dealflow from secondary trading of famously illiquid assets sounds like a lot! Good for them — sounds like they’ve found a hidden oasis. 

Making money from trading inefficient and illiquid assets is a strategy as old as capitalism itself. It can be immensely profitable. But that profit is partly a reflection of the time and effort it takes to source those assets. 

Going back to the first section of this newsletter, it sort of follows that funds running strategies like this could run up quite high costs. As these funds proliferate and get bigger, maybe charge-backs to LPs will rise — but then again, liquidity should get easier to find as the secondary market grows, so maybe it’s a wash.

Got any intel on secondary private credit trading? Get in touch at team@9fin.com.