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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 lending funds typically offer a higher spread for similar credit quality?

Direct lending spreads are higher mainly because investors are paid for illiquidity and the complexity of privately negotiated, bilateral origination. These loans rarely trade and are valued by models, so lenders require extra yield compared with similar-quality syndicated loans that have market pricing.

  1. ACompensation for illiquidity and the complexity of bilateral originationCorrect
  2. BGuaranteed principal protection from the fund sponsor
  3. CDaily market pricing that reduces valuation uncertainty
  4. DLower covenant protection that reduces default risk

Explanation

Direct loans are privately negotiated, rarely traded and hard to value, so investors demand an illiquidity and complexity premium. Daily market pricing is a feature of syndicated loans, not direct lending. Weaker covenants would raise, not lower, risk, and sponsors do not guarantee principal.

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