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Private Credit's Profits Face Increased Scrutiny in the Market

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Investors Question Fairness of Excess Returns for Direct-Lending Funds

Private credit funds have been generating significant profits due to rising interest rates, leading investors to question the fairness of these excess returns. With a floating rate lending model, fund managers benefit from higher yields as base rates increase, allowing them to surpass hurdle rates and collect additional profit. However, limited partners (LPs) are now seeking more flexibility in how the carry, or profit share, is calculated. Some LPs are advocating for pegging hurdle rates to central bank rates, aligning returns with monetary policy. This demand for flexibility reflects LPs' increasing power in the private credit industry, which has seen a surge in new fund entries. Smaller credit firms may struggle to compete as LPs prefer larger, established firms. The discussion around hurdle rates highlights LPs' willingness to assert their influence and seek fairer terms in private credit investments.

Implications of Excess Returns Debate for New Businesses in Private Credit Industry

The ongoing debate around the fairness of excess returns in direct-lending funds could have significant implications for new businesses in the private credit industry. As investors question the windfall profits generated by fund managers due to rising interest rates, new firms may need to rethink their profit-sharing models to ensure fairness and attract investment.

Adapting to Investor Demand for Flexibility

The growing demand for flexibility in how the carry is calculated signals a shift in investor expectations. New businesses in the private credit industry may need to consider innovative profit-sharing models, such as pegging hurdle rates to central bank rates, to align with these expectations and secure investment.
Competing in a Crowded Market
The surge in new fund entries in the private credit industry, coupled with LPs' preference for larger, established firms, presents a significant challenge for new businesses. To compete effectively, these firms may need to demonstrate their ability to adapt to changing investor demands and market conditions. In conclusion, the discussion around the fairness of excess returns in direct-lending funds offers valuable insights for new businesses in the private credit industry. By adapting to investor demands for flexibility and fairness, these businesses can position themselves for success in a competitive market.
Story First Published at: https://financialpost.com/pmn/business-pmn/private-credits-lavish-profits-are-coming-under-scrutiny
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