How to Evaluate a Private Credit Fund: 12-Step Due Diligence Checklist for Accredited Investors
Private Credit Fund Due Diligence: 12-Step Check How to Evaluate a Private Credit Fund: 12-Step Due Diligence Checklist for Accredited Investors TL;DR: Private credit has delivered roughly 4% net-of-f
How to Evaluate a Private Credit Fund: 12-Step Due Diligence Checklist for Accredited Investors
TL;DR: Private credit has delivered roughly 4% net-of-fee premium returns over public credit since 2004, but manager selection is the single variable that separates those gains from losses. Run every fund through this 12-step checklist before you write a check.
The Cliffwater Direct Lending Index (CDLI) tracks approximately $295 billion across 14,000 loans and records historical default losses of roughly 1% per year since its 2004 inception. Senior secured portfolios tracked through the CDLI-S cut that loss rate to about 0.25% annually. Those numbers look reassuring. Here is the part no fund marketer puts on the cover slide: both figures describe the aggregate. Individual managers vary wildly around that average. I've watched LPs lose money in private credit not because defaults were high but because they couldn't read the manager's track record. This checklist is how you read it.
Why Manager Selection Matters More Than Strategy
The private credit market has grown past $5 trillion globally. Cambridge Associates tracks 799 private credit funds representing more than $871 billion in market capitalization, publishing vintage-year DPI and TVPI data so you can compare performance across time periods. The sheer volume of capital chasing private credit deals has created a predictable problem: fee-laden, covenant-light structures assembled by managers who can raise money but cannot underwrite.
Two funds with an identical "direct lending to middle-market companies" strategy can produce 8% net returns in one case and 3% net in another. The difference is almost never the strategy description. It is credit discipline, covenant enforcement, portfolio concentration management, and whether the manager has actually worked through a credit cycle. A fund manager who started in 2012 and has only operated in low-rate environments has never been tested.
Fee drag compounds the problem. Unleveraged private credit costs investors roughly 2% annually in combined management fees and carried interest, versus about 1% for public credit instruments. That gap gets recovered — private credit has historically offered a 4% net-of-fee return premium according to Morningstar's analysis of CDLI-U-NOF versus public credit benchmarks , but only when the underlying manager earns it. A mediocre manager with a 2% fee structure will eat your premium and hand you a public-credit-equivalent return at three times the illiquidity.
Manager selection is also where understanding the credit structure you're investing in matters most. Senior secured direct lending, unitranche, mezzanine, and distressed-for-control are different animals with different risk profiles, and a manager's edge in one does not transfer automatically to another.
The 12-Step Due Diligence Checklist
Work through these steps in order. Each one either unlocks the next or gives you a reason to stop.
| # | Step | What to Look For |
|---|---|---|
| 1 | Vintage-year DPI and TVPI | Request realized DPI for all funds older than five years. A fund with a 2017 or 2018 vintage that cannot show a DPI above 1.0x has not returned your principal. Compare against Cambridge Associates private credit vintage-year benchmarks. If the manager refuses to provide vintage-specific data, that is an answer. |
| 2 | Default rate history | Ask for gross default rates by year, not just loss rates. Many managers report net of recoveries, which can hide high default frequencies masked by aggressive recovery assumptions. Benchmark against the CDLI's 1% annual default loss for broad portfolios. Senior secured focused funds should be closer to CDLI-S at 0.25%. |
| 3 | Portfolio concentration | Any single borrower exceeding 5% of NAV is a concentration flag. Any single industry exceeding 20% deserves a hard question. Concentration risk killed more private credit portfolios in 2020 than any systemic factor. Ask for the top-10 positions as a percentage of NAV. |
| 4 | Covenant discipline | Ask what percentage of loans in the current portfolio carry maintenance covenants versus covenant-lite structures. A manager who has drifted toward covenant-lite over the past three years to win deals is telling you they are competing on structure rather than underwriting quality. That is how zombie loans are born. |
| 5 | Interest coverage and DSCR | Ask for portfolio-weighted average Debt Service Coverage Ratio and interest coverage ratio (EBITDA/cash interest). In a higher-rate environment, borrowers who looked fine at 4% base rates face real stress at 6-7%. A portfolio-level DSCR below 1.5x deserves scrutiny. Ask how many loans are on a watch list. |
| 6 | Loan-to-Value ratios | Request LTV distributions across the portfolio, not just the average. A 50% average LTV can still include 30% of the portfolio above 70% LTV. Know the distribution. Senior secured loans should generally stay below 65% LTV in most credit environments. |
| 7 | Fee structure transparency | Map every layer: management fee, carried interest, origination fees, monitoring fees, and any fees paid to affiliated entities. ILPA fee reporting templates exist for a reason. If the manager resists filling one out, your all-in fee load is probably higher than the headline rate suggests. Some funds charge management fees on committed rather than deployed capital, which means you pay for idle money. |
| 8 | Leverage at the fund level | Direct lending funds often use structural leverage through credit lines, CLOs, or repo facilities to amplify returns. Ask for the debt-to-equity ratio at the fund level, not just the borrower level. A fund running 1.5x leverage in a credit downturn can face margin calls or forced asset sales. Know exactly what the maximum allowable leverage is in the LP agreement. |
| 9 | Team tenure and key-person provisions | Private credit returns are generated by specific people making specific credit decisions. Ask how long the current investment team has worked together. Check for key-person clauses in the LP agreement that trigger investor protections if senior partners depart. A fund where the lead portfolio manager left 18 months ago is a different fund than the one you're being shown the track record of. Read more about LP agreement red flags before signing anything. |
| 10 | Liquidity terms and gate provisions | Private credit is illiquid by nature, but the terms vary significantly. Lock-up periods, redemption gates, and side-pocket provisions all affect when you can access capital. Align the fund's liquidity structure with your own capital timeline. Some private credit structures in real estate come with quarterly redemption windows that sound appealing until a credit event triggers a gate. Understand the gating conditions specifically. |
| 11 | Deal sourcing and sponsor relationships | Ask what percentage of deal flow comes from private equity sponsors versus direct origination. Sponsor-backed deals offer PE firm credit support and operational expertise but also carry risks when the PE firm has its own capital pressures. Direct origination tends to produce better pricing but requires stronger underwriting infrastructure. The Silver Point Capital framework for evaluating direct lending managers emphasizes sourcing channel diversity as a proxy for competitive positioning. A manager who gets 90% of deals from two PE sponsors has a dependency risk most LPs underestimate. |
| 12 | Downside scenario and stress testing | Ask the manager to walk you through their 2020 COVID experience and their 2022-2023 rate-hike impact. What happened to NAV? Did any borrowers request interest payment deferrals? How many loans were modified? A manager who answers this question with a clean narrative and no losses either ran an unusually conservative portfolio or is not being straight with you. Also ask for their forward stress scenario: what does NAV look like if base rates rise another 150 basis points? |
Red Flags That Should Make You Walk Away
Some issues are not checkboxes to weigh. They are exits.
- No audited financials. Any fund that cannot provide audited financial statements from an independent, recognized accounting firm is not ready for your capital regardless of its other merits.
- Zombie loan denial. If you ask whether any loans are on non-accrual status or being extended repeatedly without principal reduction, and the manager says "none" without showing you the watch-list data, walk away. Every active direct lending portfolio has workouts. A clean answer is a dishonest one.
- Refuse to fill out an ILPA fee template. The ILPA Fee Reporting Template is an industry standard. Managers who refuse to complete it are protecting opacity, not their intellectual property.
- Performance track record that doesn't separate net-of-fee from gross. Gross returns tell you almost nothing. The only number that matters is net-of-fee, net-of-carried-interest return. If the fund packages both in a single blended figure, ask them to separate it. If they cannot, that is your answer.
- No prior cycle experience on the team. A team with no members who held portfolio responsibility through 2008-2009 or even 2015-2016 commodity credit stress has never made the hard decision to enforce a covenant versus waive it to avoid crystallizing a loss. Covenant waivers that extend a zombie loan are how 1% annual default rates become 8% in a single vintage year.
- Excessive fund leverage with no cap. If the LP agreement allows the manager to run fund-level leverage above 2x debt-to-equity without any investor notification or approval right, the downside scenario is no longer bounded by the underlying portfolio credit quality. It is bounded by whether the credit facility gets called.
Questions to Ask the Fund Manager Directly
The following questions are worth asking in an in-person meeting or detailed call. Pay attention to how they answer, not just what they say. Confidence paired with data is reassuring. Confidence without data is a sales pitch.
- What is your realized DPI for each fund vintage older than five years, net of fees and carried interest?
- What was your portfolio-level default rate in 2020, and how many loans required modification or restructuring?
- What percentage of your current portfolio carries maintenance covenants, and how many covenant waivers did you grant in the past 24 months?
- What is the weighted average interest coverage ratio across the portfolio today, and how has it changed since rates rose in 2022?
- How many loans are currently on your internal watch list, and what percentage of NAV do they represent?
- Will you complete an ILPA fee reporting template, including origination fees and any fees paid to affiliated entities?
- What is the fund's maximum allowable leverage, and what is the current draw on your credit facility?
- Walk me through your three largest realized losses. What went wrong and what did you do about it?
- How is deal flow sourced, and what percentage comes from three or fewer PE sponsor relationships?
- What are the gate and redemption provisions if 20% or more of LPs request redemption in the same quarter?
- What key-person provisions exist in the LP agreement, and have any named key persons departed in the past three years?
- What happens to my capital if you need to sell portfolio positions to meet redemptions or credit facility requirements?
Chicago Atlantic's research on evaluating private credit funds covers similar terrain from the manager's perspective, which is useful for understanding how a well-run fund answers these questions versus a poorly-run one.
Benchmarking Your Way to an Informed Decision
Do not accept a fund's return claims in isolation. Run them against the Cambridge Associates private credit benchmarks for the same vintage year and strategy type. A 2021-vintage direct lending fund that claims 9% gross returns needs to be compared against the quartile distributions for that cohort, not against the manager's prior 2018 fund.
Private credit investing pairs naturally with other alternative income sources. Note investing and private credit passive income structures often target similar accredited investors and can help you build a diversified private credit allocation across managers, vintages, and credit segments rather than concentrating in a single fund.
The Morningstar comparison of CDLI-U-NOF (unleveraged, net of fees) versus investment-grade public credit gives you a clean baseline: private credit should deliver roughly 4 percentage points of net-of-fee return premium to justify the illiquidity, the complexity, and the operational overhead of due diligence. If a fund cannot demonstrate a realistic path to that premium, or its fee structure makes it mathematically impossible, you have your answer before you sign anything.
The S&P/LSTA Leveraged Loan Index provides another useful public-market anchor for benchmarking what the liquid version of similar credit exposure returns, before accounting for illiquidity premium and manager alpha.
Private credit done well is one of the most attractive risk-adjusted returns available to accredited investors right now. Private credit done carelessly is an expensive way to learn that 1% aggregate default rates mean nothing when you picked the wrong manager. The 12 steps above exist to make sure you are in the first category.
Author Disclosure: Jeff Barnes, MBA has no personal position in any company, fund, or platform named in this article. Angel Investors Network has no current commercial relationship with any party mentioned. AIN provides marketing and education services, not investment advice. Past performance does not guarantee future results. All investments involve risk, including loss of principal.
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About the Author
Jeff Barnes, MBA