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Royce Stone Capital has urged sophisticated investors to examine how private credit returns are divided between borrowers, fund managers and investors. The case was set out by Private Credit Expert Tarek Omar in a new article on direct lending.
Omar said investors should look beyond a fund's headline distribution rate and assess how much of a borrower's payments reaches them after fees, retained margins and other costs. He argued that investors with sufficient capital and the ability to assess transactions may secure a larger share of loan income by funding selected loans directly rather than through pooled funds.
His central point is that a published yield does not capture the difference between holding units in a lending fund and selecting an individual loan, its borrower and its security. In the direct model he describes, investors can review a transaction and the proposed allocation of income before deciding whether to participate.
"Every layer between the borrower and the investor takes a share of the return," said Tarek Omar, Private Credit Expert at Royce Stone Capital.
He said the comparison should focus on the gap between what the borrower pays and what the investor ultimately receives. Depending on the fund structure, that gap may be shaped by management fees, performance fees, borrower-paid establishment fees and interest margins retained by the manager.
Costs and trade-offs
Omar also acknowledged that direct lending carries its own costs and risks, including origination expenses, legal work, administration and recovery costs, as well as the potential for credit losses.
That means a proper comparison cannot simply pit an individual loan's gross interest rate against a fund's net distribution. Instead, investors need to consider the full economics of each model after expenses and any losses.
The article outlines a deal-by-deal approach to assessing borrowers, including the intended use of funds, property or asset valuations, the ranking of security and the expected repayment strategy before any money is committed.
Under that approach, investors can reject transactions that do not meet their requirements rather than leave every lending decision to a pooled fund manager. Omar said this level of control matters not only when a loan is written, but also if the borrower later runs into trouble.
Control in default
He said the loan documents shape the lender's rights, the security available and the steps that can be taken if repayment fails. Reviewing those arrangements in advance is key to the direct-lending case.
Omar cited second mortgages as one example of why investor resources can matter in distressed situations. An investor with enough capital to pay out a first mortgage may have options during a default that an investor without that extra capacity lacks.
He also noted the limits of that approach. Paying out a senior lender can increase the amount of capital at risk, depends on the loan's legal structure and does not guarantee recovery.
Default interest presents another complication because it still must be collected. A single direct loan can also leave an investor with concentrated exposure to one borrower, unlike a diversified private credit fund that spreads risk across multiple loans.
Funds still have a role
Well-run private credit funds continue to serve a purpose for investors who want diversification and delegated decision-making. Omar's argument is aimed at investors who have the means to analyse and manage individual transactions and are willing to weigh the added work and risk against the prospect of retaining more of the borrower's payments.
The Melbourne-based firm operates in private capital and corporate advisory and sources and structures private lending transactions for wholesale investors, including family offices and high-net-worth investors. It also has a commercial interest in direct lending, the model highlighted in Omar's article.
The debate comes as private credit remains under close scrutiny from investors seeking yield outside traditional fixed-income markets. Omar's position is that, for some sophisticated investors, the key question is not only what a fund distributes, but who decides which loans are made and what rights exist if those loans go wrong.