Private Credit Titans Win the Incentive Fee Lottery

The $1.6 trillion private credit market is enjoying a “golden moment,” in the words of one Blackstone Inc. executive, as banks retreat from risky lending and investors flock to funds offering double-digit returns on corporate loans. But those jumping on the bandwagon shouldn’t forget private credit fees are very lucrative too. As this asset class goes mainstream and mints billionaires, investors — aka limited partners — should insist on lower costs, and oppose incentives that can reward managers for little effort.

From a fee perspective, private credit is a sweet gig. There’s a 1% to 2% asset-management fee1, plus a further take of around 15% of profit once a specified return threshold is exceeded, typically around 6%. Once that triggers, a “catchup” ensures the managers receive their share of the entire profit, not just the income in excess of the hurdle.

A 6% hurdle might have made sense when interest rates were near zero, but it represents little challenge now that US and UK benchmark rates are above 5%. Private credit loans have floating interest rates, so borrowers are often paying 10% once a spread is included. In other words, managers can’t really fail to get their performance bonus, providing defaults don’t spoil the party.

“If you have a credit fund that is now enjoying 500 basis points of excess return because the base rate has gone up, that basically all flows into that accrued incentive fee bucket,” Michael Arougheti, co-founder of private credit giant Ares Management Corp. told investors in September. Fixed hurdle rates are “well-entrenched market conventions” and “nobody” is trying to impugn their value, he added.2

Private Credit's 'Golden Moment'