With investors seeking alternatives to traditional asset classes like stocks and bonds, private credit funds have become an increasingly popular topic of late. A new area of investment for many, the debate has been around the best structure for these funds - closed-ended private funds, open-ended funds, long-term asset funds and investment trusts, being the current options.

In this article, Albane Poulin, Head of Private Credit at Gravis Capital Management, looks at each of these structures in detail, explaining how they operate in the broader investment landscape, and outlining the pros and cons Defined Benefit (DB) and Defined Contribution (DC) pension allocators should be considering.

One of the longest-standing structures for private credit has been closed-ended private funds. They were designed for sophisticated and patient investors such as insurance companies, DB schemes, LGPS and sovereign funds and raise capital for a short period of time - typically 12 to 24 months - and then close, so the capital of the fund is fixed.

Investors subscribe for limited partner (LP) interest in the fund, so have limited liability (to the size of their investment) while the asset manager (General Partner or GP) has unlimited liability and is responsible for all management decisions. The fixed capital structure of closed-ended funds provides a stable capital base, allowing fund managers to invest in illiquid private credit assets. Closed-ended funds also have a fixed lifespan, which typically ranges between five to ten years, aligning with the investment horizon of the assets they invest in.

Investors in closed-ended funds benefit from access to high-return, illiquid investments, that are usually not accessible through more fluid structures. They also allow fund managers to focus on maximising returns without the pressure of meeting redemption demands.

Closed-ended funds typically distribute recurring income and return capital as the loans mature, with some funds incorporating the concept of recycling capital for a certain period of time. For loans maturing after the termination date, GPs can offer LPs to elect to exit or stay through a continuation vehicle. NAV is typically calculated on a quarterly basis.

The majority of the capital allocated to private credit is still invested through closed-ended funds, as it is simpler with a certainty on termination date. The main disadvantage with a closed-ended fund is the lack of liquidity and the fact that LPs do not have the right to call their interest until the end of the fund’s life.

As investors are seeking greater liquidity, managers have explored alternatives with evergreen structures.

Open-ended funds have no finite lifespan and their fund managers can raise a continuous stream of capital, leading to increased flexibility, as they can adjust their investment strategy in response to changing market conditions. As such, they provide liquidity, making it appealing for investors to manage their portfolios. Open-ended funds typically invest in a mix of liquid and illiquid assets.

NAV is typically calculated on a quarterly basis and a robust valuation policy is required as it drives investment and disinvestment decisions. While higher liquidity can offer comfort to investors, it can cause challenges, with returns impacted by large volumes of redemptions, which can force managers to sell assets prematurely. To mitigate this, managers typically include a lock-up period at the beginning of the fund’s life, with redemption request limitations (a cap of 5% per quarter, for example, and 90-day notice period), ability to defer redemption (to avoid selling assets) and subscription (if the pipeline of new transactions is deemed to be insufficient by managers).

Additionally, managers typically maintain a minimum allocation to cash and liquid assets to allow for possible redemption requests. The need to balance liquid and illiquid assets may therefore constrain the fund’s ability to achieve higher returns.

Long-term asset funds (LTAFs) are a new type of UK authorised open-ended fund, created so that a broader investor base can invest in a wide range of illiquid assets such as private equity, real estate, infrastructure and private debt. LTAFs have been designed specifically with UK DC pension schemes in mind, as there was a gap for a product that could invest in illiquid assets with regular subscriptions and not be exposed to market sentiment (as opposed to Investment Trusts).

Due to the illiquid nature of the underlying investments, the FCA does not permit redemptions from LTAFs more frequently than monthly. Asset illiquidity is balanced by the fund’s structure, which includes limited redemption windows and extended notice periods for withdrawals (at least 90 days). As such, fund managers shouldn’t need to liquidate assets quickly to meet redemption demands, thus preserving the value of long-term investments.

LTAFs offer investors consistent, long-term capital growth, as fund managers typically hold onto investments until they reach their full value. LTAFs are therefore an adequate structure for a sticky investor base such as DC, given employees participating into these pension schemes typically do not change their default allocation chosen by the fund manager. It is worth noting, however, that the process of launching an LTAF can take up to one year. There have been a limited number of funds launched to date.

Investment trusts pool investor funds together and spread them over a diversified portfolio of assets, including private credit, that offer potentially higher returns due to their illiquid nature. An investment trust operates as a publicly traded company, and issues a fixed number of shares that are traded on a stock exchange. They often provide a high level of diversification, as they invest in a range of assets such as senior loans, mezzanine debt, and high-yield credit facilities. The structure of investment trusts includes oversight by a board of directors, which ensures that investors’ interests are aligned with the management of the portfolio, providing an extra layer of security and confidence.

However, shares have limited liquidity and, like other closed-ended funds, negative market sentiment can lead to significant discounts to NAV. This can create a buying opportunity for new investors, but could also send the wrong signal: persistent discounts to NAV can lead shareholders to vote for a discontinuation, for example. Current rules on cost disclosure have also discouraged managers from investing in investment trusts, as the ongoing costs that are published are artificially high. A long-waited reform could boost appetite again.

The type of private credit fund structure adopted by an investor depends on the nature and composition of their underlying credit portfolio, which can vary widely. Therefore, understanding the difference between closed-ended private funds, open-ended funds, long-term asset funds and investment trusts is crucial for any investor seeking to allocate capital into private credit markets. Each structure has its own distinct advantages and disadvantages By carefully considering each structure and applying it to their own portfolio, investors can make informed investment decisions and enhance their portfolio by investing in private credit funds.

Important Information 

This article has been prepared by Gravis Capital Management Ltd (“Gravis”) and is for information purposes only. It is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. Any recipients of this article outside the UK should inform themselves of and observe any applicable legal or regulatory requirements in their jurisdiction and are treated as having represented that they are able to receive this article without contravention of any law or regulation in the jurisdiction in which they reside or conduct business.​ 

This article should not be considered as a recommendation, invitation or inducement that any investor should subscribe for, dispose of or purchase any such securities or enter into any other transaction in a fund affiliated with Gravis. No undertaking, representation, warranty or other assurance, express or implied, is made or given by or on behalf of  Gravis or any of its respective directors, officers, partners, employees, agents or advisers or any other person as to the accuracy or completeness of the information or opinions contained in this article and no responsibility or liability is accepted by any of them for any such information or opinions or for any errors, omissions, misstatements, negligence or otherwise for any other communication written or otherwise. In addition, Gravis does not undertake any obligation to update or to correct any inaccuracies which may become apparent. The information in this article is subject to updating, completion, revision, further verification and amendment without notice.​ 

Past performance is no guarantee of future performance.  

Gravis Capital Management Ltd is authorised and regulated by the Financial Conduct Authority; registered in England and Wales No: 10471852 and its principal place of business is at 24 Savile Row, London W1S 2ES.​