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FRM Part II · FRM Exam Part II · Private Markets Investing

A pension fund is comparing a senior secured direct lending fund with a broadly syndicated leveraged loan fund. Which feature most commonly explains why direct loans are expected to offer an illiquidity premium over syndicated loans?

Direct loans are held by few lenders and have little or no active secondary market, so investors cannot exit quickly at fair value. This illiquidity is what the extra spread over syndicated loans compensates, since direct loans are usually senior secured and floating rate.

  1. ADirect loans are typically held by a small group of lenders with no active secondary market, so positions cannot be sold quickly at fair valueCorrect
  2. BDirect loans are typically unsecured and rank below high-yield bonds in the capital structure
  3. CDirect loans are always priced at fixed rates, which removes interest rate exposure
  4. DDirect loans are rated by agencies and traded on exchanges, which raises their transparency

Explanation

Direct lending is bilateral or club lending with limited secondary trading, so investors bear illiquidity and expect compensation. Direct loans are usually senior secured and floating rate, which rules out the unsecured, fixed-rate and exchange-traded descriptions.

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