The boom and the marriage between credit strategies and withdrawal rights

First wave of private credit funds, the ones without withdrawal right

Traditionally, credit funds were structured, like buyout fund, with a lifespan of around 7 to 10 years before investors saw their capital returned. The absence of withdrawal rights makes perfect sense for buyout funds as they require long term control over cash to carry out their buy-and-build strategy. In addition, determining withdrawal prices in a buyout context is nearly impossible because there’s no cash flow or transparent market for the assets. For credit strategies, this is different: there is no buy and build and pricing is easier because credit generates instant and predictable cash flow. Credit strategies can thus be a suitable candidate for a “marriage” with withdrawal rights.

Credit funds and withdrawal rights - a fruitful marriage and the boom  

The possibility of withdrawal rights paves the way for credit funds with a perpetual life spam, or in industry jargon: evergreen funds. Evergreen funds avoid that investors must hop from one fixed term credit fund to another, which comes each time with a costly due diligence. They also benefit sponsors: permanent access to capital makes them reliable financing partners, giving them a competitive edge in securing high‑quality credit deals. The first evergreen credit products were launched in the US and the trend was picked up around mid-2023 in Europe.

Different types or marriages: Vintage, Run Off and NAV based

Credit funds with a more clunky deal flow, less diversified and riskier portfolio tend to rely on a vintage evergreen model. Such fund offers different “buckets” that separately function as closed-ended funds. At the end of each bucket’s lifecycle, investors are automatically rolled into the next one unless they elect to withdraw. Their money is ultimately returned once the final bucket in which they participated has liquidated its assets. Other funds, knows as run off evergreen funds, answer to withdrawals only when the proportion of underlying assets allocable to the withdrawing investor is liquidated in its natural order. Funds that can offer a more continuous deal flow, a highly diversified portfolio with more senior type of loans, can offer withdrawals based on net asset value. Hybrid evergreen models exist. All these models were easy to mirror in Luxembourg fund vehicles and as these vehicles are also easy to distribute in the EU they now take the European centre stage in the evergreen credit world.  

Every marriage needs maintenance - managing liquidity stress

Much like an actual marriage, a marriage between a private credit strategy and withdrawal right can only endure if clear limitations are set. Private credit assets are relatively illiquid. Granting unlimited withdrawal rights means that the fund could be forced into fire sales at significant discounts to answer to accumulating withdrawal requests, ultimately harming the investors who remain in the fund and potentially triggering systemic risk. Traditionally, there was ample freedom to design withdrawal restrictions, but these days are over. Nowadays, pre-defined liquidity management tools will need to be hardwired by funds that may face liquidity stress. For example, the volume of redemptions may be capped, or investors wishing to withdraw could be required to pay a withdrawal fee.

Is it a smooth marriage, will we reach the golden wedding anniversary?

Although liquidity management tools are seldom activated during periods of market stability, the unpredictable nature of global markets has already shown that there are times when investors flock to liquidity, making the use of these tools necessary. Imposing restrictions on withdrawals generates tension for investors, who are unable to access their funds, and also poses reputational challenges for fund managers. In the end it is a necessary compromise between exposure to illiquid assets and offering withdrawal rights. As with marriage, evergreen credit funds will face-ups and downs, but like most marriages, they are here to stay. Making it to the golden wedding anniversary requires solid liquidity tools, transparency and open lines of communication with investors.

This article was first published by Paperjam.