By Belinda Bible, COO, Corval Avenue
Private Credit Alchemy – Can Illiquid Investments Be Turned Into Liquid Gold?
Three of the biggest names in private credit – Blue Owl Capital, Ares Management and Apollo Global Management- have moved to limit redemptions from certain funds in their latest liquidity window and, in doing so, have rattled investors and led the press to be critical of the private credit sector (unfairly in my opinion).
Inherent Illiquidity
All three operate predominantly in corporate private credit, as opposed to real estate private credit where Corval Avenue operates, reflecting differences in approach. However illiquidity is a fundamental characteristic of both asset classes, which may impact the timing and ease of access to invested capital. A clear understanding of these features and the pros and cons of illiquidity is important when assessing and investing in this asset class. .
Private credit funds invest in illiquid assets such as direct loans to middle-market companies, structured credit, distressed debt or real estate loans. These investments are typically illiquid, meaning they cannot be easily sold like listed shares and may take time to exit, sometimes at a discount. A key advantage of this asset class is that illiquidity and complexity may be associated with higher return potential, often referred to as the illiquidity and complexity premia. However, these same characteristics also introduce risks as the assets are illiquid and more complex.
Manufacturing Liquidity
What makes the current situation particularly interesting is that private credit funds have attempted to manage some of the illiquidity by developing “evergreen” funds that do not have a fixed end-date after which the investment matures and is returned. Instead, the evergreen structure allows investors to invest more capital or request redemptions at set times of the year, usually quarterly.
This means fund managers are required to manage liquidity, effectively creating cash flow flexibility within an inherently illiquid structure. There are a number of ways this can be achieved, with the main ones set out below:-
| Cash buffers and ongoing inflows |
Maintaining a portion of the portfolio in cash or listed securities, and relying on new investor subscriptions to help fund redemptions |
| Redemption limits or gates |
Restrict the amount of capital that can be withdrawn at any one time (more on this later.) |
| Secondary asset sales |
Selling assets on the private secondary market, which may involve a discount to stated value |
| Borrow |
Use a credit line to meet short term liquidity needs and fund redemptions |
| Liquidity sleeves |
Allocate part of the portfolio to more liquid private credit, listed assets or short-duration loans |
Liquid to a Point – Gating
Gating has become an increasingly important mechanism, particularly as the asset class has grown rapidly and attracted a broader range of investors. At its core, gating refers to restrictions placed on investor withdrawals, limiting the amount of capital that can be redeemed during a specific period.
When a fund imposes a gate, it caps redemptions during a given redemption period. For example, a fund might limit withdrawals to 5% or 10% of total assets per quarter. If investor redemption requests exceed this threshold, they are either reduced proportionally or deferred to future periods. This mechanism helps mitigate a “run on the fund,” where large-scale withdrawals may force fund managers to sell assets quickly and potentially at discounted prices.
From a fund manager’s perspective, gating is a risk management tool. It allows managers to maintain investment discipline, rather than being required to liquidate assets under pressure. By slowing the pace of redemptions, gating may assist in preserving portfolio value and supporting equitable treatment of investors.
For investors, however, gating introduces trade-offs. On one hand, it may provide a layer of protection against value erosion associated with forced asset sales. On the other hand, it reduces liquidity and creates uncertainty around access to capital. This can be especially problematic for investors with short-term investment horizons or those who underestimate the illiquid nature of private credit investments.
Fund Managers – Not Magicians
While fund managers can use a range of tools to manage liquidity, including evergreen structures and gating mechanisms, they cannot remove the fundamental illiquidity of the underlying assets. These structures are designed to manage, rather than eliminate, liquidity constraints.
Keeping these liquidity characteristics in mind, it becomes easier to understand how private credit operates and how it may fit within a boarder investment context.
