An institution weighs a private credit fund yielding 13% gross, with 1.5% annual losses, a 1.5% fee and 10% carry over an 8% hurdle, locked for five years, against listed high yield at 9.5% with 1.2% losses and 0.6% fees. Compare net returns and say whether the illiquidity premium is being paid.

Net of losses, fees and carry, Kaustubh returns about 9.0% a year against 7.7% for listed high yield, a premium of 1.3 points, not 3.5. Extra losses take 0.3 points, the higher fee 0.9 and carry 1.0. That falls short of the trust's 2 point requirement for a five-year lock, so on these terms the illiquidity premium is not being paid. Dropping the catch-up would lift the premium to 2.1 points.

A job offer in another city that pays 30% more is not a 30% raise until you take off the higher rent and the longer commute. Yields work the same way. The borrower pays Kaustubh 13%, but some loans default, the manager charges a fee, and above the hurdle the manager also shares in the profit. Private credit loses 1.5 points to losses, 1.5 to the fee and 1.0 to carry, netting 9.0%; listed high yield loses 1.2 and 0.6, netting 7.7%. Of the 3.5 point gap, 0.3 goes to higher losses, 0.9 to higher fees and 1.0 to carry, leaving 1.3.

After losses and the management fee the fund earns 10.0%. The trust keeps the first 8%. With a full catch-up, the manager then takes everything until it holds 10% of all the profit, which happens once the return reaches 8.89%; beyond that the split is 90 to 10. Because 10.0% is past the catch-up, the manager takes 10% of the whole 10.0%, 1.0 point, not 10% of the 2 points above the hurdle. Without a catch-up the carry would be 10% of 2 points, 0.2, and the trust would net 9.8%.

The lock has a cost even if nothing goes wrong. The trust cannot rebalance, cannot sell in a crisis to meet pensions or buy cheaper assets, and sees quarterly valuations that move less than market prices, which makes the risk look smaller than it is. Against its own requirement of 2 points, 1.3 points is not enough, so on these terms the trust is not being paid for the illiquidity. On Rs 100 crore over five years, the net premium is worth about Rs 9.0 crore (Rs 153.9 crore against Rs 144.9 crore). The headline yields would have suggested about Rs 27 crore.

Losses are the number the manager knows best and the trust knows least. Hold high yield at 1.2% and the premium falls one for one with private credit losses until carry switches off. The premium reaches 2 points only if losses stay below 0.72% a year, and disappears entirely at 3.8%. In a broad credit cycle the picture is less one-sided: if losses reach 4% in private credit and 3.2% in high yield, the fund drops below its hurdle, carry vanishes, and the premium is 1.8 points, because the carry acts as a partial cushion.

So the judgement turns on terms, not the asset class. Removing the catch-up lifts the premium to 2.1 points, enough to meet the requirement on its own, which makes it the first thing to negotiate. The committee should also ask for the manager's loss record through a full credit cycle, not just recent years, and check how the fee is charged during the investment period. The limitation of the whole comparison is that both loss rates are estimates: private credit losses are reported with a lag and through the manager's own marks, so treat the 1.5% as the start of the analysis, not its conclusion.