How does Carry Work at a Credit Fund?
I’m coming from a PE fund targeting 20%+ IRR with a standard 2/ 20 fee structure and am Curious how carry and fees work within the context of a private credit fund (whether distressed, direct lending, special sits etc.). Obviously, most credit funds aren’t targeting 20% IRRs, so, are the $ fees just lower than PE / is the money for the IPs not as good or are their mitigating factors (lower hurdles, higher carry %, higher management fees, more AUM per IP, so more carry $s to go around, etc.). Also, is there market standard on European vs American waterfall and vesting periods in private credit or does it vary fund to fund?
Lower pref (usually 8% for leveraged; 6% for unleveraged), lots of leverage and typically larger funds (by committed capital) with a higher number of deals than PE. Some managers also charge additional flat fees to recoup admin costs. European waterfall is still the market standard.
Carry works at a credit fund by providing investors with a return on their investment. Carry typically refers to the interest rate or yield that is earned on an investment, and is usually expressed as a percentage. Carry is calculated by subtracting the cost of borrowing the funds from the interest rate that the fund earns on its investments. The higher the interest rate earned on the investment, the higher the carry earned by the fund. Carry is an important component of a credit fund's returns, as it allows the fund to generate income while minimizing its risk.
ChatGPT?
To shed some more light on this:
Generally, if a PE fund hits a homerun, carry will be far far better than in any PC fund.
However, lets face it, many PE funds actually don't hit home runs (regularly).
For my European fund, we get less management fee (~1%, depends on commitment size of LP) and also obviously generate less return, but mitigating factors are: i) lower hurdle rate (5%, unlevered fund), ii) significantly more money per investment professional compared to most PE funds (24 IP, o/w 6 MDs; 5bn AUM latest fund), iii) faster fund cycles (fund closed in autumn 2022, now 65%+ commmited, currently slashing the brakes only due to difficult fundraising times) and iv) more stability, i.e. if we don't have several bad investments (we never wrote-off principal in 15 years) your carry expectation is relatively certain.
Thanks, but...at the risk of sounding redundant, how exactly does Carry work?
Depends on where you want to start. Essentially at my firm, we are allocated percentage / basis points of the carry pool. I'm also relatively new and just received my first allocation, but I assume due to tax reasons (capital gains are taxed lower), we officially buy shares in our fund vehicle as we would be LPs, however in a different share class reserved for investment professionals (for me its a low 5-digit amount which is not fully called immediately). Once the fund gets realised after all assets are sold, ordinary LPs receive their full nominal investment + 5% annual return. After that, the investment professionals receive their nominal investment plus receive their 5% return. Finally, the GP (i.e. the fund) catches-up to 5%. Then, profits are share 85% (LPs) / 15% (GPs). To sum it up, the investment professionals get their principial investment back + return just as a normal LP + our basis / percentage points of the realized carry pool from the GP (if we generated returns >5%). For simplicity, if we have a carried interest pool of €200m, our GP (multi-strategy manager) takes 50% and distributes that to shareholders, middle office, investor relations etc. The remaining €100m is split among the investment team. If my allocation was 20 bps, I will receive €200k carry, taxed as capital gains (here only 25%).
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