The Liquidity Illusion in Private Credit

Many private credit funds advertise monthly or quarterly redemption windows. The underlying assets are typically loans with multi-year maturities. That gap between fund-level liquidity and asset-level liquidity is the most underappreciated risk in the asset class today. The honest answer is not to engineer the liquidity. It is to choose strategies where the liquidity is real.

What investors are being told, and what they are buying

Pick up almost any open-ended private credit offer document in the Australian market, and you will find a redemption clause that promises liquidity on a relatively short cycle — daily, monthly, or quarterly, with various notice periods attached. The investor reads this and reasonably concludes that they can exit the fund at short notice if they need their capital back. In calm markets, that conclusion is broadly correct. Funds meet redemptions out of cash, new inflows, and the natural amortisation of their loan books.

What the offer document often does not make obvious is the gap between that advertised liquidity and the liquidity profile of the underlying assets. A direct corporate loan made to a private equity sponsor typically runs for five to seven years. A real estate development loan typically runs eighteen months to three years. These are not tradeable instruments. Their fair value can only be realised by holding them to maturity, by negotiating an early repayment with the borrower, or by selling them in a thin and sometimes non-existent secondary market at a meaningful discount.

When markets are calm, the gap is invisible. When markets are not calm, the gap is exactly where the problem lives. Investors who learn the difference when they want their money are learning at precisely the wrong time.

Why the gap matters under stress

Liquidity stress in private credit funds is not a hypothetical. It has been observed in every major dislocation of the last twenty years. In the 2008 financial crisis, in 2020 during the COVID shock, and in the rates-driven repricing of 2022, open-ended funds across multiple jurisdictions invoked redemption gates, suspended withdrawals, or imposed exit fees that effectively re-priced an investor's exit at a discount to the prevailing NAV.

These outcomes are not, in themselves, evidence of poor management. They can also reflect good management—gating may be the most equitable way to protect remaining investors from forced selling at distressed prices. But they show that the liquidity advertised in the offer document did not match the liquidity the investor experienced. The investor thought they were holding a daily-priced security. They were actually holding a multi-year exposure with a discretionary exit window.

"Investors who learn the gap between advertised and actual liquidity at the moment they want their money are learning at precisely the wrong time."

We do not believe this is a reason to avoid open-ended private credit. We do believe it is a reason to interrogate the source of the liquidity that any open-ended fund offers. Liquidity has to come from somewhere. If it does not come from the natural cash flow of the underlying assets, it comes from new investor inflows, leverage, or manager discretion — and each of those sources has its own failure mode.

Three sources of liquidity, three different qualities

The first source of fund-level liquidity is the natural amortisation of the underlying loan book. Every month, borrowers pay scheduled principal and interest, and those cash flows can be redirected to meet redemptions. This is the highest-quality form of liquidity because it is contractual. Borrowers pay it, not other investors or leverage. It is the same source of cash the fund uses to pay distributions in the ordinary course.

The second source is new investor inflows. In a growing market, this is reliable — there is always new capital available to fund redemptions. But this source fails exactly when it is most needed, because the same conditions that drive existing investors to redeem are the conditions that deter new investors from subscribing.

The third source is leverage. Funds may have a credit facility with a bank that allows them to borrow against the loan book to meet short-term redemptions. This is sometimes the right tool to bridge a temporary mismatch. But leverage to meet redemptions is procyclical — drawing the facility raises the fund's leverage ratio at exactly the moment the underlying assets are under stress, which is the worst time to increase the portfolio's structural risk.

An investor reading a offer document rarely gets a clear picture of which of these three sources the fund is relying on. The right question to ask the manager is direct: under stress, where does the cash to pay my redemption actually come from? A manager whose answer leans heavily on the second or third source is offering liquidity that is real until it is not.

The role of asset duration

The deepest determinant of how real a fund's advertised liquidity is comes down to one variable: the weighted-average life of the underlying assets. A fund whose loan book has a five-year average life can only generate, by amortisation, roughly 1/60th of its NAV in cash each month. A fund whose loan book has a one-year average life generates roughly 1/12th. The same redemption window that requires the first fund to find external liquidity can be comfortably met by the second fund out of natural cash flow.

This is why we have always argued that the most honest way to design an open-ended private credit fund is to match the liquidity terms to the duration of the underlying assets. If the assets are short-dated, the fund can offer regular liquidity without engineering it. If the assets are long-dated, the fund should either lock investors up for a period commensurate with the underlying duration or be very explicit about the discretionary nature of the redemption mechanism.

The Australian business lending opportunity sits, fortunately, on the short-duration end of this spectrum. The underlying loans typically have weighted-average lives of six to eighteen months. Working capital lines, asset-backed receivables, equipment finance, and short-tenor business loans all amortise quickly. A fund built on these assets can offer monthly or quarterly liquidity terms supported by genuine, contractual cash flow rather than inflows or leverage.

What securitised structures add

Investing in business lending through a securitised warehouse structure compounds the liquidity advantage. The warehouse has a defined payment waterfall, with senior bank funders ahead of equity and mezzanine investors. As loans amortise, cash flows up the waterfall in a contractual, transparent way. Investors at each level receive distributions on a predictable schedule that maps to the underlying receivables.

Because the senior funder is typically a major Australian bank, the warehouse is also subject to detailed eligibility criteria, ongoing reporting, and independent oversight. This is not the same as monthly NAV liquidity in the public market sense — these are not daily-traded securities. But it is also not the discretionary liquidity that some open-ended private credit funds rely on. The cash arrives because borrowers pay, the waterfall directs it, and investors receive their share. The mechanism is mechanical, not discretionary, and that difference matters under stress.

"The most honest way to design liquidity in a private credit fund is to match the liquidity terms to the duration of the underlying assets."

What advisers should look for

When evaluating a private credit fund's liquidity profile, four questions are particularly useful. First, what is the weighted-average life of the underlying loan book, and how does it compare to the redemption notice period offered to investors? Second, in the manager's last three years of monthly cash flow, what proportion of redemptions could have been met purely from natural amortisation, with no reliance on inflows or leverage? Third, what is the manager's policy on gating, side-pockets, and exit fees, and under what conditions have those tools historically been deployed? Fourth, in the event of a sustained redemption queue, what is the fund's process for meeting redemptions without disadvantaging remaining investors?

A manager who can answer these questions clearly, with reference to actual cash flow data and a documented governance process, is a manager taking liquidity seriously. A manager who cannot — or who relies on the abstract assertion that "we have plenty of liquidity" — is one whose answer should give an adviser pause.

Liquidity is a feature, not a free lunch

The deeper point in this paper is that liquidity in private credit is not free. Every form of liquidity has a cost, either in lower returns, in structural risk, or in the discretionary nature of the redemption mechanism. An investor told they are getting institutional-grade returns and daily liquidity from an asset class that is, by definition, illiquid should ask where the catch is. The catch is almost always in the structure.

The investor who is willing to accept liquidity terms that match the underlying asset duration — quarterly with notice, say, on a short-dated business lending portfolio — is paying nothing for that liquidity, because it arises naturally. That is the profile we believe is most defensible for accredited and adviser-driven capital, and it is the profile around which we have built Aura Private Credit's Australian business lending strategy.

The Aura view

We have spent a decade building a platform for Australian business lending through securitised warehouse structures, and the platform's liquidity properties are no accident. The short weighted-average life of the underlying loans, combined with the warehouse's contractual payment waterfall, creates a liquidity profile that is honest about what is being offered. We do not promise daily liquidity on assets that take eighteen months to roll. We offer notice periods commensurate with the portfolio's natural cash flow, and we run cash management with conservatism in mind.

We also believe that being explicit about liquidity is part of the fiduciary contract with investors. This means being clear about where redemption cash will come from, under what conditions that cash might arrive more slowly, and what governance protections ensure equitable treatment. That clarity is, in our view, what professional private credit management looks like.

The liquidity illusion in private credit is real. It is the gap between what the offer document says and what the underlying portfolio can actually deliver under stress. Closing that gap — by matching structure to substance — is one of the most important responsibilities of a serious manager in this asset class. We have built our platform with that responsibility front of mind.

A note on closed-end alternatives

It is worth saying explicitly that closed-end funds, with multi-year lock-ups, are not a worse answer to the liquidity question than open-ended ones. They are simply an honest answer for strategies where the underlying assets are genuinely long-duration. A direct lending fund running five-year corporate loans should, in our view, be structured as a closed-end vehicle with a defined investment period and harvest period. Trying to wrap those same assets in a vehicle that promises monthly liquidity creates the illusion.

Investors should not see closed-end structures as a constraint to be avoided, but as a feature that aligns the vehicle with the assets it holds. The right question is not "how liquid is this fund" but "is the liquidity offered consistent with what is realistically deliverable from the underlying portfolio?" If the answer is yes, the fund is being honest with its investors. If the answer is no, the fund is asking its investors to bear a hidden risk that may not surface for years.

Conclusion

Australian advisers and investors are increasingly sophisticated consumers of private credit, and liquidity is one of the most important conversations they can have with a manager. The right answer is not necessarily "the most liquid fund wins". The right answer is the fund where the liquidity terms, asset duration, and structural protections align — and where the manager is willing to discuss the mechanics openly rather than hide behind generic reassurances.

We invite that conversation. We believe Australian business lending through securitised warehouse structures, with monthly or quarterly redemption terms supported by genuine cash flow amortisation, offers one of the most defensible liquidity profiles available in the asset class today. It is not a free lunch. There is no free lunch in liquidity. But it is a fair lunch, priced honestly, and that is what investors deserve.

The next time an open-ended private credit fund is presented to your client, the most useful question to ask is the simplest: where does the cash to fund a redemption actually come from? If the manager can walk you through the answer, with reference to the duration of the loan book, the structure of the cash flow waterfall, and the fund's historical experience through periods of stress, that is a manager who has thought about the question carefully. If the manager cannot, the question is the most important one you have asked all year.

This paper is general in nature and does not constitute personal advice. Investors should consider their own circumstances and read the relevant offer document in full before investing.