Key Takeaways
- • KKR argues that deal structure, not only asset selection, is a major driver of direct lending returns, and promotes a hybrid Institutional Open-Ended Structure as an alternative to traditional drawdown funds.
- • KKR says traditional drawdown funds typically reach only 85-90% deployment by the end of the investment period, and that effective funded exposure over an investor's life rarely exceeds 50%.
- • The proposed structure calls 100% of each quarterly tranche only after the prior tranche is fully called, with new investors entering at the latest quarterly NAV, which KKR says speeds deployment and income generation.
- • After a lock-up, investors would have periodic options to harvest exposure or remain invested, which KKR says mitigates reinvestment risk and reduces the need to re-underwrite successive vintages.
- • KKR's return claims are illustrative, based on model fee rates, current forward base rate curves and spread assumptions, and assume evergreen funds are 100% called within 12-18 months versus 90% in 36 months for closed-end funds.
Summary
KKR, in a publication titled "Structure as the Secret Sauce: Evolving Beyond Traditional Fund Structures in Direct Lending," argues that the structure of direct lending transactions and vehicles is an underappreciated source of value as private credit becomes a mainstream allocation. The firm notes that rising interest rates and market volatility have broadened investor interest in direct lending, drawing a diverse base ranging from individuals to large institutional allocators. KKR emphasizes a risk-first approach, including dynamic bottom-up underwriting that accounts for geopolitical developments such as tariff and trade policy and technologies such as generative AI, alongside top-down diversification across industries and issuers.
The paper identifies three shortcomings of traditional closed-end drawdown funds. First, capital is called pro-rata regardless of commitment date, so investors can take three to four years to reach deployment targets. Second, funds typically reach about 85-90% deployment by the end of the investment period, with 10-15% held for unfunded commitments and defensive follow-ons; combined with slow ramp-up, KKR says effective funded exposure over an investor's life rarely exceeds 50%. Third, once the investment period ends, investors receive paydowns with no option to remain invested, creating reinvestment risk and requiring repeated underwriting of new vintages.
As an alternative, KKR proposes a hybrid Institutional Open-Ended Structure. Under a queue system, capital is called from the next quarter's tranche only after the prior tranche is fully called, allowing earlier commitments to be deployed first. New investors enter at the latest quarterly NAV and can review the existing portfolio during diligence, avoiding blind-pool risk. KKR says managers can call 100% of a tranche while still reserving for unfunded commitments. After a lock-up period, investors may elect at predetermined times whether to harvest or remain invested, and each investor's distribution and reinvestment choices operate independently. KKR also says structures that avoid accelerated liquidity options, gates and liquid non-direct-lending holdings can offer purer direct lending exposure with less cash drag.
KKR argues that gross returns can be improved either by raising asset-level yields, which increases risk, or by faster and more complete deployment, which it considers the preferable route. It states that net returns can be further enhanced through efficient structures and improved fee schedules. The return illustrations in the publication are hypothetical: they rely on model fee rates, current expectations for forward base rates, prevailing spread levels and average OID and fees, and assume evergreen funds reach 100% called in 12-18 months versus 90% called in 36 months for closed-end funds. These figures are KKR's projections rather than realized performance.
The paper identifies three shortcomings of traditional closed-end drawdown funds. First, capital is called pro-rata regardless of commitment date, so investors can take three to four years to reach deployment targets. Second, funds typically reach about 85-90% deployment by the end of the investment period, with 10-15% held for unfunded commitments and defensive follow-ons; combined with slow ramp-up, KKR says effective funded exposure over an investor's life rarely exceeds 50%. Third, once the investment period ends, investors receive paydowns with no option to remain invested, creating reinvestment risk and requiring repeated underwriting of new vintages.
As an alternative, KKR proposes a hybrid Institutional Open-Ended Structure. Under a queue system, capital is called from the next quarter's tranche only after the prior tranche is fully called, allowing earlier commitments to be deployed first. New investors enter at the latest quarterly NAV and can review the existing portfolio during diligence, avoiding blind-pool risk. KKR says managers can call 100% of a tranche while still reserving for unfunded commitments. After a lock-up period, investors may elect at predetermined times whether to harvest or remain invested, and each investor's distribution and reinvestment choices operate independently. KKR also says structures that avoid accelerated liquidity options, gates and liquid non-direct-lending holdings can offer purer direct lending exposure with less cash drag.
KKR argues that gross returns can be improved either by raising asset-level yields, which increases risk, or by faster and more complete deployment, which it considers the preferable route. It states that net returns can be further enhanced through efficient structures and improved fee schedules. The return illustrations in the publication are hypothetical: they rely on model fee rates, current expectations for forward base rates, prevailing spread levels and average OID and fees, and assume evergreen funds reach 100% called in 12-18 months versus 90% called in 36 months for closed-end funds. These figures are KKR's projections rather than realized performance.
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