Risk-Adjusting the Returns to Private Debt Funds

Isil Erel, Thomas Flanagan, Michael Weisbach
March 2024

Abstract
Private debt funds are the fastest growing segment of the private capital market. We evaluate their risk-adjusted returns, applying a cash-flow based method to form a replicating
portfolio that mimics their risk profiles. Using both equity and debt benchmarks to measure risk, a typical private debt fund produces an insignificant abnormal return to its investors. However, gross-of-fee abnormal returns are positive, and using only debt benchmarks also leads to positive abnormal returns as funds contain equity risks. The rates at which private debt funds lend appear to be high enough to offset the funds’ fees and risks, but not high enough to exceed both their fees and investors’ risk-adjusted rates of return.