Private credit investments have long been viewed as one of the main beneficiaries of the higher interest-rate environment. However, recent redemption limits imposed by certain evergreen vehicles have raised concerns among investors. Do you see this as a temporary liquidity issue, or as a structural warning sign for the broader industry?

Evergreen funds are usually structured with quarterly redemption clauses, requiring investors to indicate in advance their wish to get out of the fund at its net asset value (NAV). The fund manager assesses these aggregated requests to serve them on a best effort basis, when there is cash available for redemption –, that is to say cash coming as a repayment of underlying investments plus any profit. 

The volume of redemptions is usually capped in evergreen funds at 3 to 5% of the NAV of evergreen funds per quarter. These limits are embedded in the conception of the product and clearly indicated. 

«The gating provides an indication of the perception of some investors but does not sum up the whole picture.»

Some evergreen fund managers communicated on the fact that recent aggregated redemption requests exceeded these limits, leading them to stop at the indicated threshold, a mechanism known as «gating». This gating provides an indication of the perception of some investors but does not sum up the whole picture. For example, evergreen funds often accept fresh capital from new investors while others have indicated their intention to leave. 

This new capital is earmarked to make new investments, and benefit to the community of existing investors. It is testament that evergreen funds and private market strategies continue to attract capital.

Are evergreen funds fundamentally the right structure for investing in illiquid assets, or do recent events expose inherent tensions between liquidity expectations and long-term investments?

Each tool has its own advantages and limits. Closed-end funds are complex at entry: they use the capital of investors as needed through «capital calls». The exit is rather straightforward: when these funds sell an asset, they distribute the cash within a short timeframe. Open-end, or evergreen, funds are straightforward at entry: the capital of investors is collected at once and then invested. 

However, the exit, as we currently witness, can be complex if a significant share of investors wants to exit together at the same time, due to the redemption limits explained above.

Direct lending is probably the strategy that would theoretically be a good match for evergreen funds: the durations are known in advance and there is regular interest collected by the fund, supporting some potential redemptions. 

«Private markets investing is first and foremost a human activity.»

Some strategies, such as venture capital, which require a long time and where exits are less predictable, might be less suited to such structures and their redemption features.

Which metrics and indicators should investors examine most closely today when evaluating a private credit fund?

Private markets investing is first and foremost a human activity. The executives managing the fund, and their incentives, matter a lot. The analysis of their track record and of current investments is of course paramount when assessing the option to invest in a new evergreen fund. 

Performance indicators are rather straightforward and measure the progression of the NAV of the assets over a designated period of time – often a calendar year. 

Risk indicators are more specific to given investment strategies. For example, for direct lending specifically, it is the average loss given default (which combines the default rate and the average implied recovery). 

«Valuations are as much an art than a science and practices.»

According to the KBRA DLD Default indices (as of 9.6.26), the average loss given default was 0.7% for direct lending overall, 1.5% for middle market direct lending, 1.9% for leverage loans and 1.2% for high yield bonds. 

Many private credit portfolios have yet to be tested by a meaningful economic downturn. How well prepared are current valuations and default assumptions for a more challenging macroeconomic environment?

Managers monitor their loans very closely. They have processes in place to value their assets and these processes are audited. Moreover, as for funds distributed in the EU, they are often subject to additional requirements. Notably, the Alternative Investment Fund Manager Directive (AIFMD) requires managers with assets above a certain threshold to have independent valuations performed on their portfolios. 

However, valuations are as much an art than a science and practices and results can diverge from one manager to another. More than the portfolios, it is the fund managers and their experience that matters. Some managers have been through the 2007-2009 global financial crisis (GFC). 

One of the questions that investors usually ask to fund managers is: Do you have a dedicated troubleshooting team to handle loans from companies that are facing difficulties? This will drive the recovery in the advent of default, and this reduce the average loss given default.

Where do you currently see the greatest mispricing opportunities in private credit, and where would you advise investors to exercise particular caution?

We advise our clients to work with established managers, with a solid track record, strong processes in place, and a clear ability to be selective and invest with discipline. These managers are the ones who effectively can select the best investment opportunities which change depending on market and industry evolutions. 

Therefore, what matters is the due diligence done on fund managers and the stability of their team. This is what we focus on when we advise our clients.

The market is increasingly being shaped by insurance companies, pension funds, and wealthy private investors. Has this influx of capital affected underwriting standards and lending discipline across the industry?

Direct lending pre-existed the GFC in the US but was effectively largely kickstarted in Western markets as commercial banks reduced their lending activity, in particular to small and midsized businesses. Essentially, alternative lending filled this significant and quickly expanding financing gap. 

«Even established market players make sometimes investments that do not perform.»

The continued growth of direct lending has attracted many fund managers with variable levels of expertise. Some might have felt the pressure to deploy capital fast, and might have accumulated less prior experience, resulting to lower lending standards. 

However, this is not true for all market participants. Still, even established market players with decades of experience make sometimes investments that do not perform. This is part of the investment risks and explains why they carefully diversify their exposure among multiple companies.

Private markets are becoming accessible to a broader investor base. Is there a risk that the industry is expanding access faster than it is educating investors about liquidity constraints and underlying risks?

The knowledge of investor varies regardless of their origin. Some of our clients are more sophisticated than some institutional investors, for example. 

Private markets have grown very significantly over the course of the last 20 to 30 years. When I started to give training sessions and lecture on private markets in 2004, this was a rather unknown asset class. I wrote the textbook on the industry in 2005, in French first, then in English a few months later. But this knowledge is not fixed. I update 10 to 15% of my training material every year, and each iteration of the books implies amending and extending the books by 20 to 40%. 

«Some of our clients are more sophisticated than some institutional investors.»

Since the industry is evolving and innovating at fast pace, it can be difficult to stay abreast of these developments without help. We spend considerable time and resources to explain the asset class and educate, and answer questions of clients to guide them to the best of our knowledge. Ultimately, we are one market participant among many others, and investors are the ones who decide and judge if their information is sufficient.

If you were building a new private market investments allocation today for a wealthy Swiss investor, how would you allocate across private equity, private credit, infrastructure, and secondaries—and why?

It all depends on four dimensions. 

First, their payout constraints: Do they need cash regularly, possibly unexpectedly, and at which level? 

Second, their risk appetite: How much loss can they reasonably face, if we ever come to that. 

Third, their current allocation with other assets classes, including their direct holdings: Is there a need to diversify some specific exposure – for example, significant real estate –, or specific wishes that the client has, for example, exclusion lists? 

«Every asset class eventually faces some tests, and private markets are no exception.»

Fourth, the size of their wealth, since private markets require a certain scale. 

Based on these elements, it is possible to start to build an allocation along five dimensions: time, geography, strategy, industry and size of assets. There is also a need to diversify among fund managers. 

Has the private credit industry encountered its first real crisis of confidence, or are we simply witnessing the natural maturation of a rapidly growing asset class?

Every asset class eventually faces some tests, and private markets are no exception. The source of these tests, the way they are unfolding and handled by market participants is specific. 

Evergreen fund dedicated to direct lending are currently tested by significant redemption demand. So far, they seem to be working as intended. 

There are multiple potential reasons for these redemption requests, ranging from individual reasons, nervousness, to portfolio rebalancing and asset allocation. The fact that closed-end funds dedicated to direct lending continue to raise significant capital each year proves that there is a continued wish to invest in the sector. 

The redemption requests from direct lending evergreen funds is therefore not necessarily representative of the full picture, and should be analysed accordingly.

Cyril Demaria-Bengochéa is Head of Private Markets Strategy & Research at Julius Baer, Zurich. Previously, he was notably in charge of private markets research at the Chief Investment Office of UBS Wealth Management.

Cyril is an Affiliate Professor at EDHEC Business School, and the author of multiple books.