The private credit industry has evolved dramatically over the past decade. What began with relatively straightforward direct lending has since expanded into a dizzying array of funding arrangements and assets that each have their own unique traits and considerations. That proliferation of sub-strategies has spurred the development of numerous types of fund structures and variations in distribution mechanics designed to address the diverse needs of all applicable parties involved in the fund process.

Against that backdrop, sponsors need to design fund waterfall structures to suit the characteristics of the underlying portfolio construction. Yield-oriented strategies emphasizing current income (e.g., senior direct lending) favor current income-driven structures that align GP incentives with income generation, while providing LPs with regular distributions. Conversely, opportunistic and capital appreciation-oriented strategies (e.g., distressed debt) typically employ the more conventional carry structures in traditional European or modified American-style waterfalls.

This first article in a two-part series describes the core asset types, features, complications and return profiles of various private credit asset classes, including infrastructure debt and dislocation funds. The second article will outline several types of waterfall structures – and relevant variations within each – that are used to align with the risk, reward and return profiles of each asset class.

See “Evolution of the Private Credit Industry and Ongoing Challenges” (Feb. 19, 2026).

Private Credit Adoption

Growth and Accelerators

It is well publicized that private credit grew as an asset class in the wake of bank retrenchment following the 2008 global financial crisis (GFC). According to PitchBook, global assets under management (AUM) exceed $2 trillion as of June 30, 2025 – up from approximately $500 billion in 2014. That growth is expected to accelerate in the coming years, with Preqin’s Global Report for Private Credit 2026 forecasting AUM to reach $4.5 trillion by 2030.

One of the most notable AUM accelerators, per PitchBook, has been private wealth channels, with perpetual private vehicles for private wealth raising $86.4 billion in H1 2025. That is expected to accelerate further as the retailization of private markets gains momentum in the coming years, as exemplified by the U.S. Department of Labor’s March 2026 proposed regulations outlining how managers of employer-sponsored 401(k) plans and other participant-directed defined contribution plans (DC Plans) can include alternative assets in the plans they manage.

Insurance companies are also responsible for the growth in private credit AUM, with insurance-related trailing 12‑month inflows to credit strategies approaching $150 billion in H1 2025 among the top seven U.S. public alternative asset managers. Life and annuity insurers held an estimated $1.8 trillion in private credit in 2025, according to a special report issued by A.M. Best.

Many large insurers – particularly asset manager-backed insurers – have increasingly turned to offshore reinsurance arrangements. Products such as multi-year guaranteed annuities have also played a central role, enabling insurers to benefit from interest rate spreads and higher yields from private credit investments while simultaneously aligning asset durations with long-term liabilities and managing duration exposure.

See “Retailization Season Is Heating Up: A Private Fund Manager’s Guide to Structuring, Procedures and Fundraising” (Jun. 12, 2025); and “Attraction of Using Insurance Dedicated Funds in Season‑and‑Sell Private Credit Structures and As ‘Evergreen’ PE Vehicles” (Jul. 19, 2022).

Headwinds

After more than a decade of explosive growth and on the cusp of expansion into 401(k) plans, headwinds for private credit have begun to emerge. Those developments are prompting some market participants to reexamine their portfolio allocations, reassess the strength of their private credit positions and inquire as to the potential systemic impact, if any, if private credit default rates rise.

Market concerns were reflected in closed-end private credit fundraising ending 2025 on a relatively weak note, which Preqin attributed to “LP concerns about tariffs, rates, or credit quality of existing credit funds.” At the same time, there has been increased manager consolidation as investor preferences have shifted to more experienced, highly diversified managers to navigate a potentially choppy credit cycle. Further, despite private credit being perceived as less correlated with public market sentiments, managers are facing more scrutiny amidst notable market developments, including:

• increased redemption requests from private credit business development companies, interval funds and other semi-liquid funds;
• well-publicized mark-downs of software-related private loan collateral values by certain banks; and
• bankruptcies among certain automotive manufacturers.

Those issues are exacerbated by increased regulatory attention private credit and insurance. Specifically, the Federal Insurance Office (FIO) and the Financial Stability Oversight Council (FSOC) have publicly acknowledged the rise in private credit/insurance inter-connectivity, and have expressed a need for market monitoring and increased transparency. Both regulators have also called on state insurance commissioners to continue progressing their regulatory work in this area.

In addition, the U.S. Department of the Treasury (which chairs FSOC) announced that it would convene a series of meetings through the summer of 2026 with domestic and international insurance regulators focused on private credit markets, and would continue to survey recent market events, emerging risks, risk management practices and outlooks for the sector. Although details remain uncertain, those meetings are expected to move forward with more formality than routine FIO/state insurance regulator coordination.

Similarly, in a joint proposal issued in April 2026, the SEC and the CFTC acknowledged the significant rise in private credit when the agencies requested public comment on whether to modify the information that advisers must report about private credit funds on Form PF.

See “Private Credit Valuations Under Pressure: Enforcement Trends, Litigation Risks and Mitigation Tactics” (May 14, 2026).

Private Credit Product Design

Overview

Private credit headwinds and tighter LP underwriting and diligence processes have increased the importance of well-tailored product design in a market that no longer competes on asset valuations alone. Instead, there is a greater focus on other factors, including:

• liquidity profile;
• ratings criteria;
• distributions to paid-in capital;
• wealth channel compatibility;
• use of leverage;
• downside protection; and
• the ability to blend asset packages into tailored product wrappers across various customized risk-adjusted return and liquidity profiles.

This competition – both within private credit and as between private credit and other asset classes – has led to a proliferation of sub-asset classes within private credit, with managers diversifying their offerings well beyond core middle-market direct lending strategies.

Nowadays, competing at the highest level often means having wide aperture sourcing funnels capable of evaluating and swiftly executing on a broad range of strategies and fund types, including:

• large cap;
• middle market;
• opportunistic;
• asset-based lending (ABL);
• special situations;
• structured products;
• specialty finance; and
• esoteric lending strategies, including:
  • distressed workouts;
  • dislocated opportunities;
  • music royalty financings;
  • infrastructure;
  • real estate;
  • public-private partnerships;
  • defense and national security financings;
  • sports;
  • GP stakes;
  • secondaries;
  • synthetic risk transfers;
  • insurance solutions; and
  • fund finance.

Capital deployment must shift nimbly in tandem with shifts in opportunities and market conditions to avoid a “race to the bottom” mentality where mono, direct lending strategists can be tempted to overextend or lose discipline in an effort to chase absolute returns.

As such, sponsors must identify and delineate the contours of the underlying portfolio to ensure that fund-level features are compatible therewith, including:

• type of collateral and security;
• yield;
• tenor;
• interest rate;
• amortization;
• capitalization requirements;
• upside and downside features;
• use of leverage;
• liquidity;
• ratings compatibility;
• cost of capital;
• return profile; and
• targeted investor base.

A mismatch between the assets and the fund-level design features can lead to unhappy investors, even if the internal rate of return (IRR) numbers are fine on paper.

Asset Class Descriptions and Features

The following are certain core asset descriptions and related return drivers of various private credit asset classes, which fund managers can flexibly adapt when determining which features align with their desired portfolio and investor base.

Direct Lending

In the immediate aftermath of the GFC, market participants often referred to direct lending as non-bank lenders providing private, senior-secured financings to sponsor-backed, middle market companies in connection with M&A deal activity. Large cap companies commanded access to traditional bank lending, and it was not immediately apparent that those companies would need alternative sources of capital. With the growth of private credit and the coronavirus pandemic’s impact, however, direct lending has become a mainstream financing source for sponsor- and non-sponsor-backed companies alike. Larger cap companies now often simultaneously solicit bids from both bank and non-bank lenders.

In addition to commanding an “illiquidity premium” (i.e., a bigger spread to benchmark rates relative to the public debt markets), direct lending typically offers more flexible features than traditional bank loans, including:

• a variety of lending structures, such as:
  • delayed draw term loans;
  • unitranche facilities;
  • revolving credit lines; and
  • first loss positions;
• increased closing speed;
• single-source execution capability;
• greater ability to digest and structure around complexity; and
• more stability through turbulent market cycles, particularly when paired with permanent, institutional capital.

Direct lending funds also often offer levered and unlevered entry points, so investors with differing risk tolerances, tax profiles or portfolio composition needs can target different return profiles while investing in the same financial instrument. In those scenarios, unlevered gross return targets often range from 6‑10%, and levered return gross targets typically range from 10‑15%.

Private direct lending remains a strong capital preservation allocation, with regular way coupon payments generating consistent current income at a relative spread to reference rates. Further, within the direct lending category there are a variety of opportunistic strategies catering to:

• a mix of first lien, second lien, mezzanine and junior unitranche positions;
• a slew of corporate borrower types, size, credit quality and use cases; and
• a variety of return profiles, based on various factors, including:
  • different portfolio compositions;
  • uses of leverage and leverage limits;
  • level of origination activity;
  • expected hold-to-maturity relative to early secondary sales; and
  • prepayments and refinancings.

The factors contributing to a broad range of return profiles also play important roles in determining the core drivers of the return, the assets’ liquidity, the distribution frequency and the right incentive structure to achieve optimal sponsor alignment.

For those reasons, direct lending was arguably the most prominent private credit strategy at the outset of the asset class. Despite the emergence of other private debt asset categories, direct lending strategies still comprised 61.5% of overall private debt AUM raised in 2025 through the end of Q3, according to Preqin.

Mezzanine Debt and Unitranche Lending

Mezzanine debt is used when borrowers require additional financing capacity beyond what traditional senior lenders are willing to provide, and when mezzanine’s subordinated position in the capital structure commands a premium return commensurate with its elevated credit risk. To that end, common use cases for mezzanine financings include leveraged buyouts, recapitalizations and add-on acquisitions.

Within the capital structure, mezzanine debt occupies a subordinated position relative to senior debt and is typically unsecured, commanding return profiles in the range of 11‑18% gross IRR. Mezzanine debt financing often incorporates a combination of cash-pay coupons; payment-in-kind interest; and equity warrants or other kickers. By comparison, unitranche lending structures blend senior and subordinated debt into a single facility, offering return profiles higher than traditional senior debt but below standalone mezzanine positions.

Unitranche facilities have grown in popularity due to their simplicity for borrowers, who benefit from dealing with a single lender or lender group rather than negotiating separate senior and mezzanine tranches, while lenders capture a blended yield that reflects the mixed risk profile of the combined facility. The growth of unitranche lending has coincided with the growth of private lenders, who are now able to underwrite much bigger tickets and carve up the allocation among lenders on the back end.

Distressed Debt and Special Situations

Distressed debt strategies generally involve the purchase of securities or loans in the secondary market at a discount, with managers identifying the “fulcrum” securities – i.e., the most subordinated part of the capital stack likely to convert into or receive equity in a bankruptcy or restructuring – which can trade at steep discounts to net asset value (NAV). By contrast, special situations strategies often involve the direct origination of hybrid structures such as convertible debt, convertible preferred equity and debt with warrants. Issuances by special situations funds are generally made with the intent of gaining control of a company experiencing some form of financial distress.

Special situations funds often intervene prior to a company’s bankruptcy, whereas distressed strategies are often involved during the bankruptcy process itself. Commensurate with the levels of risk they entail, distressed debt and special situations strategies represent the higher returning end of the private credit spectrum, with gross IRR targets often ranging from 15‑25%.

Some managers have blended their traditional distressed debt businesses into broader “opportunity” or “capital solutions” funds, naturally shifting capital from distressed towards “opportunistic” classifications as further described below. Those labels can often make it difficult to establish bright-line strategy classifications, but allow managers to flexibly shift deployment to pursue the most attractive investment opportunities.

Asset‑Based Lending

ABL strategies are distinguished by their reliance on specific assets or receivables as collateral, rather than the general creditworthiness of the corporate borrower. ABL encompasses a wide range of sub-strategies, including:

• trade finance;
• receivables financing;
• equipment finance;
• litigation finance;
• royalty financing;
• residential mortgages;
• consumer credit portfolios;
• student loans;
• buy now, pay later loans;
• whole business securitizations;
• automobile leases;
• aviation finance;
• maritime;
• fund finance; and
• significant risk transfer transactions.

Return profiles for ABL strategies can vary widely based on how one characterizes ABL and the use of leverage, and often range from 6‑17% gross IRR. The lower end of the range reflects the lower risk profile that can exist in certain situations via the use of tight covenants and close collateral monitoring, in addition to the inherent defensive features of ABL such as its self-amortizing nature and recourse to collateral.

The ABL market has traditionally been dominated by specialty lenders, platform originators, banks and securitizations, which has led many private credit managers to source deals by pursuing strategic partnerships with banking institutions, online lending platforms and other asset originators. Proper sourcing and execution of ABL strategies often requires specialization in niche industries or sectors, including valuing potentially esoteric assets, and as such, can present a unique advantage to a sponsor seeking to offer a differentiated capability.

However, a proliferation of ABL participants in the market has also led to some lower quality lenders. The sheet size of the potential addressable ABL market – alongside the securitizable nature of cash-generating, self-amortizing assets – has also drawn parallels to the residential mortgage-backed securitizations that contributed to the GFC. Accordingly, regulators have inquired as to the systemic impact on the economy if some private lenders adopt loose ABL underwriting standards.

Infrastructure Debt

Infrastructure debt has emerged as a compelling component of private credit portfolios, providing diversification, attractive risk-adjusted returns, low default rates and downside protection. The strategy focuses on lending to long-term, real asset projects such as toll road operators, utilities, renewable energy facilities, data centers and telecommunications infrastructure, all of which typically possess several notable characteristics:

• the provision of essential services with relatively inelastic demand;
• long asset lives;
• stable and visible cashflow generation under long-term contracts;
• high barriers to entry;
• inflation-correlated revenues; and
• high operating margins.

Infrastructure debt return profiles are typically in the 5‑10% gross IRR range and often feature inflation-linked returns. Infrastructure debt has also demonstrated low correlation to corporate credit, making it an effective diversifier within broader private credit portfolios. The strategy has proven particularly attractive to insurance companies and pension funds seeking stable long-term income with low volatility.

Real Estate Debt

Real estate debt strategies encompass bridge loans, mezzanine financing and preferred equity structures secured by hard real estate assets. Common use cases include financing for transitional assets, development projects and refinancing bridges where borrowers require flexible capital solutions that traditional lenders may be unwilling or unable to provide. The return profiles for real estate debt typically range from 8‑15% gross IRR depending on the risk profile and capital structure position.

NAV Lending and Subscription Facilities

NAV lending has emerged as a growing niche within private credit, involving loans secured by the NAV of PE fund portfolios that GPs can use during liquidity crunches or for fund-level financings. Subscription loans are a related type of financing, which are collateralized by LP commitments to PE funds. Both NAV and subscription facilities are historically considered lower-risk lending by banks, with return profiles typically in the 10‑15% gross IRR range, depending on structure.

See “The State of NAV Loan Facilities in the PE Industry and Current Obstacles to Widespread Adoption” (Feb. 9, 2023).

Venture Debt

Venture debt provides financing to startups and growth-stage companies to help entrepreneurs extend their runway to exit without further diluting ownership. Startups also use venture debt to restructure their capitalization as they position for an IPO. Given the prominent role of artificial intelligence in the venture capital community, venture debt providers may benefit as founders hunt for a cheaper cost of capital relative to equity.

The return profiles for venture debt strategies are typically in the 10‑18% gross IRR range comprising both cash yield and equity upside through warrants or other equity kickers. The collateral base for venture debt – often secured by intellectual property or equity warrants – is typically lighter than traditional corporate lending due to the companies often being cashflow negative.

Credit Opportunities and Dislocation Funds

Credit opportunities funds represent a flexible, multi-strategy approach to private credit investing, with broad mandates that allow managers to deploy capital across the risk spectrum, depending on market conditions. The breadth of the mandate distinguishes credit opportunities funds from more narrowly focused strategies, providing managers with the flexibility to pursue relative value across sub-asset classes while maintaining a cohesive risk management framework. These funds typically target gross IRRs in the 10‑18% range and may invest in performing senior loans; stressed or distressed credits; structured products; and rescue financings.

Dislocation funds are a subset of opportunistic credit strategies specifically designed to capitalize on market dislocations – i.e., periods when forced selling, liquidity crunches or macroeconomic stress create pricing inefficiencies in credit markets. These funds often target gross IRRs of 15‑25% – similar to distressed debt strategies – but with a focus on acquiring performing or lightly stressed credits at discounted prices rather than engaging in traditional bankruptcy or restructuring processes. Dislocation funds often have shorter investment periods and accelerated deployment timelines to capture episodic opportunities, and their returns are driven primarily by the discount to fair value at entry rather than operational improvements or restructuring gains.

See this three-part series on contingent dislocation funds and market disruptions: “Appeal, Application and Adoption Before Adverse Events” (Mar. 15, 2022); “Unique Mechanisms That Position Them to Pounce” (Mar. 22, 2022); and “Suitable Fund Participants and Potential Downsides to Avoid” (Mar. 29, 2022).

 

Samuel Weber is a partner in the New York office of Willkie Farr. He advises fund sponsors on a wide range of strategic and operational matters, including the formation, marketing and management of private investment funds; portfolio investment activities; fund regulatory and compliance matters; and firm ownership and operational issues. He has extensive experience advising managers of credit platforms on a wide range of issues, including the formation of closed-end and open-end direct lending, mezzanine, asset-based credit, special situations, specialty finance, aviation, opportunistic and distressed funds. He also advises diversified asset managers in connection with the launch of their credit platforms, including on related regulatory, compliance and operational issues.

John M. Knapke is a partner in the New York office of Willkie Farr. His practice focuses on private investment funds. In the area of fund formation, he has assisted sponsors with the formation of closed-end domestic and international funds, including funds focused on growth equity, distressed debt, energy, mezzanine and real estate investments. In addition to his sponsor-side work, he regularly advises investors in connection with primary and secondary investments.

On the heels of President Donald J. Trump’s executive order in August 2025 (Executive Order), the private funds industry has eagerly awaited guidance from the U.S. Department of Labor (DOL) to further promote the retailization of the private markets. That arrived in the form of the DOL’s proposed regulations (Proposal), which established a process-based safe harbor that plan fiduciaries could reference to satisfy their duty of prudence under the Employee Retirement Income Security Act of 1974 (ERISA) when including alternative assets in employer-sponsored 401(k) plans and other participant-directed defined contribution plans (DC Plans).

Although the safe harbor offers a helpful path for plan fiduciaries to follow, a number of ambiguities remain that the industry will want to address before the comment period ends on June 1, 2026. Among the concerns raised by legal experts interviewed by the Private Equity Law Report, the Proposal inadequately accounts for the difficulties some plan participants may have in understanding the fee structures of alternative assets – and their distinct differences to traditional plan assets – to satisfy the ERISA duty of prudence.

This second article in a two-part series analyzes the process-based, six-factor safe harbor in the Proposal that supplements the duty of prudence under ERISA, including some practical limitations faced by plan fiduciaries and private fund managers. The first article summarized how the Proposal clarifies the ERISA duty of prudence’s application to alternative assets, considered the Proposal’s relationship with the Executive Order and offered analysis from legal experts about its practical impact on the industry.

See “SEC Investor Advisory Committee’s Recommendations to Facilitate Retail Access to Private Markets” (Oct. 30, 2025).

Six‑Factor Safe Harbor

The central feature of the Proposal is a process-based safe harbor consisting of a non-exhaustive list of six factors that plan fiduciaries can follow to mitigate ERISA litigation risks. Paragraph (f) of the Proposal introduces the process-based safe harbor, with paragraphs (g) through (l) therein detailing the six specific factors for plan fiduciaries to take into consideration.

The DOL explicitly stated that the safe harbor in the Proposal is intended to supplement and expand upon what it means to “act accordingly” under the 1979 Investment Duties Regulation and, therefore, satisfy the duty of prudence under ERISA. “If a plan provider is to have a wider range of alternative investments available to include in its plan lineup, then some sort of clear guidance is needed as to what various factors should be considered that would shift the presumption of prudence in their favor,” summarized Gibson Dunn partner Blake E. Estes.

Paragraph (g): Performance

The first criterion for selecting a designated investment alternative, identified in paragraph (g), is performance. Paragraph (g) requires a fiduciary to give appropriate consideration to a reasonable number of similar investment alternatives, and then make a determination that the designated investment alternative’s risk-adjusted expected returns – net of anticipated fees and expenses and over an appropriate time horizon – will enable plan participants to maximize their investment’s risk-adjusted returns.

Expected returns are not the sole consideration, the Proposal emphasizes. Any performance assessment by a fiduciary must take into account risks that investors will face, including:

• economic risks;
• sector risks;
• investment-specific risks; and
• counterparty risks.

It is equally important to give due consideration to plan participants’ time horizon. Given the long-term nature of retirement savings, an investment alternative offering the highest possible return within the shortest period of time is not automatically the most desirable and appropriate offering. At the same time, plan participants at certain ages do not have unlimited time for investment strategies to generate maximum returns.

“The makeup of plan participants, including their investment sophistication, financial situation and age, are important considerations for planning or investment committee members,” observed Haynes Boone counsel Thomas M. Hogan. “As to age, are they relatively young, or are they nearing or well past retirement and they don’t have a long-time investment horizon?”

For more on the retailization trend and related risks, see our three-part series: “Institutional LPs’ Growing Concerns Over Retailization of the Private Funds Industry” (Jan. 8, 2026); “Specific Concerns About How Retailization Could Impact Institutional Investors’ Interests” (Jan. 22, 2026); and “Protective Measures Institutional Investors Can Adopt to Mitigate Risks of Retailization” (Feb. 5, 2026).

Paragraph (h): Fees

Paragraph (h) sets forth one of the most important safe harbor provisions by requiring plan fiduciaries to consider fees when selecting between investment options. Once again, the methodology must evaluate a reasonable number of alternatives. The fiduciary must address whether the fees and expenses of the designated investment alternative are appropriate, with reference to risk-adjusted expected returns net of fees and expenses.

Notably, paragraph (h) stipulates that Section 404(A)(1)(b) under ERISA, and paragraph (h) of the Proposal, will not be considered to have been violated just because a fiduciary did not pick out the alternative with the lowest fees and expenses. In some cases, a fiduciary will deem it appropriate to pay more for better services, the DOL acknowledged.

Fee Disclosures

As to fee disclosure requirements, plan sponsors have to provide plan participants with a summary of what investment options are available to them in the 401(k) plan so they can understand what the fees are when making an informed decision.

The vast preponderance of 401(k) plans contain investment options consisting of mutual funds, exchange-traded funds or other products with fairly standardized fee structures that are easily comparable, Estes noted. “You can compare one mutual fund to another fairly easily, just in terms of the basis point increments and the fee and expense loads,” he observed. “Whereas, when including private market investments, even those in [vehicles registered under the Investment Company Act of 1940] (e.g., interval funds), the fee structure is more complex and less conducive to comparison with other investment options,” he pointed out.

That gap may be bridged by plan fiduciaries, understanding that a fiduciary may evaluate a particular private market option and decide its fees seem reasonable based on the potential value provided, Estes observed. “Fiduciaries struggle with how to reconcile that and depict it in a format that allows plan participants to easily compare that private market investment with another traditional asset option that has a completely different fee structure and that presents different risks and benefits,” he observed. “It’s not obvious how the DOL can necessarily scope all that out in a proposed rule, but that is an area where you may continue to see some friction as plan fiduciaries work things out.”

See “SEC Roundtable Examines Valuation, Structuring and Fee Issues for Retailization of Private Markets” (Apr. 2, 2026).

Investor Education and Sophistication

Another problem is that plan participants often do not look at the detailed fee and expense disclosures that are prepared by plan fiduciaries, Hogan observed. That’s potentially problematic for plan sponsors given that recent legal developments have specifically addressed the degree of participants’ awareness and how they are informed about fees. “The U.S. Supreme Court issued a unanimous opinion in 2020 [in Intel Corp. Investment Policy Committee v. Sulyma] providing that mere receipt of a fee disclosure document by a plan participant does not constitute actual knowledge of the information,” he explained. “So there’s always this push, particularly from the smaller employers with limited resources – more education is necessary, and that often falls on the plan providers.”

Even if plan fiduciaries put together suitable materials and work to educate plan participants, that may not ultimately fulfill their duties. “It also falls on plan and investment committees and employers to ask, ‘Do my plan participants have a suitable level of sophistication to understand what the applicable fees and fee structures entail at both the plan and individual level?’” Hogan noted. “If they feel it is not the right move, then it is my view that they should not put the particular offering on their menu,” he reasoned.

The risk, however, is that omitting a designated investment alternative due to insufficient investor sophistication could raise questions from plan participants about why an option with positive risk-adjusted returns was not included in a plan menu, Hogan observed. The six safe harbor factors in the Proposal are particularly for helping plan fiduciaries facing that issue, he asserted. “Maybe a thorough process that documents procedural prudence, looks at alternative options and decides not to include an option in the plan would be enough to avoid litigation.”

Paragraph (i): Liquidity

Under paragraph (i) of the Proposal, a fiduciary must consider whether the designated investment alternative will have enough liquidity to fulfill the needs of the plan participants and the plan as a whole. In many cases, the DOL noted, alternative asset investments are less liquid than the funds comprised of publicly traded stocks and bonds that plan fiduciaries offer to plan participants. The younger age of some retirement savers – and their correspondingly longer time horizons – may leave them well positioned to benefit from a liquidity premium.

Here, the DOL makes another important safe harbor available, stipulating that plans are not required to offer fully liquid investment options. At the same time, plan fiduciaries must ensure that investments can deliver on liquidity that is promised to plan participants. They must also consider whether their plans’ liquidity needs – and redemptions by other plans or their own plan participants – might negatively affect the designated investment alternative’s liquidity.

Arguably, the Proposal does not really go far toward specifically addressing the incorporation of individual PE funds into 401(k) plans, Hogan argued. “Assume there is a 401(k) plan that an individual is trying to withdraw their money from upon retirement. How would they do that if their investment is tied up in a traditional PE fund, which is illiquid?” he asked. “I was curious as to whether the DOL was going to craft a regulation that would cover that issue for purposes of DC Plans.”

“The liquidity needs of a defined benefit plan (i.e., the traditional type of plan investor in PE funds) are much different than those of a DC Plan where individual participants have their own, separate accounts,” concurred Katten Muchin partner Mitchel C. Pahl. “Whereas certain investment funds are illiquid by their nature, 401(k) plans require liquidity by their nature,” he noted. “How can the liquidity component of an inherently illiquid PE fund be addressed with sufficient specificity and clarity to enable a plan fiduciary of a DC Plan to say, ‘This will meet the needs of my plan constituency?’”

See “Structural Challenges PE Sponsors Must Overcome to Expand Into 401(k)s (Part One of Two)” (Oct. 16, 2025).

Paragraph (j): Valuation

Under paragraph (j) of the Proposal, a fiduciary must consider and determine that the designated investment alternative has taken appropriate measures to ensure it can be timely and accurately valued in a manner consistent with the plan’s needs. For investments that trade daily on a public exchange, that would mean that the fiduciary relies on asset valuations from a national securities exchange. A fiduciary using public exchange valuations is understood to have made objective and analytical determinations about valuations, drawing upon all publicly available information and avoiding real or perceived conflicts of interest.

With the aforementioned example, the Proposal acknowledges the standards and protocols that are common within the hedge fund realm, Hogan noted. “Outside of the 401(k) plan world, when a private fund manager that holds plan assets is trying to determine its performance fees and carried interest, there is a requirement under DOL guidance to base the valuations on objective criteria,” he explained. “If such objective criteria are unavailable, then a plan fiduciary needs to obtain representations as to valuations, liquidity and complexity from an independent professional.”

“The other side of the issue is, again, the smaller plans – are they going to do this? Maybe that effort will prove prohibitive and they will not offer these types of alternative assets in their DC Plans,” Hogan added.

See “After Retail Gets Access to Alts, Then What?” (Mar. 5, 2026); and “SBAI Introduces New Standards and Accompanying Guidance on Valuing Illiquid Assets” (Apr. 3, 2025).

Paragraph (k): Performance Benchmark

Paragraph (k) stresses the centrality of making use of a “meaningful” benchmark when choosing designated investment alternatives. A meaningful benchmark, according to the Proposal, is understood to be “an investment, strategy, index, or other comparator that has similar mandates, strategies, objectives, and risks to the designated investment alternative.” The criterion here is likeness between the comparator and the alternative, it clarifies.

In accordance with paragraph (k), a fiduciary must carefully consider whether each alternative investment has such a benchmark, comparing the risk-adjusted expected returns on a net-of-fee basis to that benchmark. If a plan fiduciary considers an investment against a benchmark that satisfies that likeness criterion, then the fiduciary will be understood to have satisfied the requirements of paragraph (k) and of Section 404(a)(1)(B) under ERISA.

Paragraph (l): Complexity

Another important factor in the safe harbor is set forth in paragraph (l), which stipulates that plan fiduciaries will not be barred from selecting investment strategies with a high degree of complexity if they use a prudent selection process.

A plan fiduciary must make a realistic determination, however, as to whether it has the experience, knowledge skills and comprehensive faculties to meet its ERISA obligations in the pursuit of such a complex strategy or whether it would be appropriate to enlist the help of an investment manager, qualified investment fiduciary or other individual, the Proposal notes. If the fiduciary decides to bring in the help of an outside expert, then that process, too, necessarily entails prudent selection that takes into account the expert’s knowledge, skill and required compensation.

Potential Impact

It is important to keep the list of six safe harbor factors in the Proposal in perspective, given that it is a non-exhaustive list and that, practically speaking, many plan fiduciaries have already been functionally relying upon them when making investment selections for their DC Plans, according to Mayer Brown partner Erin K. Cho.

“The list of factors in the Proposal is an extra layer of protection for fiduciaries, and not the only means by which they can comply with their fiduciary duties,” Cho said. “Moreover, analysis of one or another of the six factors may not be particularly relevant, depending on the facts and circumstances, as to every DC Plan’s designated investment alternative. So the intent here is really for it to be a suggested list,” she added. “To be clear, non-compliance with any of the six factors does not necessarily mean that fiduciaries have breached their duty of prudence.”

The Institutional Limited Partners Association (ILPA) released the results of its second annual LP sentiment study. ILPA gauged its members’ perspectives on allocations to PE, return expectations, commitment size, number of manager relationships, plans for adjusting PE exposure in 2026, staffing, changes in negotiating leverage, key negotiation issues and co‑investments. This article discusses the key findings from the study, with commentary from Seyfarth Shaw partner Steven A. Richman and Sidley Austin partner Michael Sabin.

See “Institutional LPs’ Growing Concerns Over Retailization of the Private Funds Industry (Part One of Three)” (Jan. 8, 2026).

Survey Demographics

ILPA conducted the study in the last quarter of 2025. The 99 respondents included senior-level investment professionals at ILPA member organizations that can be categorized as follows:

• Large Firms: firms with more than $16 billion assets under management (AUM), constituting nearly half of respondents (43%);
• Mid-Size Firms: firms with between $2 billion and $15.9 billion AUM, constituting 36% of respondents; and
• Small Firms: firms with less than $2 billion AUM, comprising 21% of respondents.

Nearly half of the respondents (42%) represented public and private pensions. The remaining respondents represented, in relatively even proportions, endowments and foundations (endowments); insurance companies; family offices; and other institutional investors. Two-thirds of respondents’ organizations are based in North America, with most of the rest (25%) based in Europe.

For another ILPA study, see “ILPA Report Assesses Institutionalization of Impact Investing Market” (Apr. 2, 2026).

PE Allocations

On average, respondents allocated approximately 17% of their AUM to PE, which, for purposes of the study, included buyout, growth and venture strategies. Large firms allocated, on average, just 10% of their AUM to PE, versus 22% by small and mid-size firms. Endowments and family offices allocated 25% and 29%, respectively, to PE, versus between 11% and 14% by each of the other types of organizations in the study.

Most respondents said their PE allocations are either at target (28%), below target but within range (35%) or above target but within range (24%). Just 14% said their allocations either are well below target (8%) or exceed the range (6%). The results were similar for mid-size and large firms. On the other hand, just 13% of respondents from small firms said they are above target, and none exceed their range.

Return Expectations

Respondents indicated that their five-year net return expectations for PE investments are:

• 1.9x net multiple on invested capital; and
• 15.7% net internal rate of return (IRR).

Three-fifths of respondents said their five-year net return assumptions for PE had not changed over the past year. Most of the rest said their assumptions had decreased by between 1% and 2% (28%) or by more than 2% (5%). The remaining 6% said their expectations were between 1% and 2% higher. Just over half of respondents expect their PE policy target to stay the same over the next five years. Most of the rest (38%) expect it to increase, versus just 10% who expect it to decrease.

“When LPs adjust their five-year expected return profile down, one of the inferences I make is that LPs anticipate that some more funds could find themselves in a clawback position,” Richman noted. “And that will certainly bring more caution to the market.” Over the past 20 years, it was rare for funds to find themselves in a clawback. “Now, in at least some instances, internal LP underwriting is positioning itself to have more managers in that position,” he added.

See “GP Clawbacks and Related Risk Mitigation Tactics LPs Pursue to Prevent Overpayment of Carried Interest (Part One of Two)” (Apr. 3, 2025).

PE Exposure

Commitment Sizes

Respondents’ average commitments to buyout funds fell mostly into the following buckets:

• below $25 million (34%);
• $25 million to $49.9 million (24%);
• $50 million to $149.9 million (31%); and
• above $150 million (8%).

Commitment size corresponds closely to firm size. In that regard, two-thirds of respondents from small firms said their average commitment size is less than $25 million. Most of the rest said average commitment size is either between $25 million and $49.9 million (10%), or between $50 million and $149.9 million (10%). The remaining 14% do not invest in buyout funds.

Most respondents from mid-size firms said their firm’s average commitment size is either less than $25 million (47%) or between $25 million and $49.9 million (44%). The remaining 9% said it is between $50 million and $149.9 million. Finally, more than three-quarters of respondents from large firms said average commitment size is at least $50 million, including 19% who said it is at least $150 million.

See “Dechert and Mergermarket 2026 PE Outlook: Fundraising Difficulties Stoke Demand for Assorted Liquidity Solutions” (Jan. 22, 2026); and “Survey Finds PE Fundraising Momentum Building Toward 2026 Uptick” (Sep. 18, 2025).

Number of Manager Relationships

More than four-fifths of respondents from small and mid-size firms said their firms have, on average, either fewer than 20 managers or between 21 and 40 managers, with similar proportions falling into each category. The remaining 14% of respondents from small firms and 15% of respondents from mid-size firms said they have more than 40 managers. On the other hand, 52% of respondents from large firms said they have more than 40 managers. Just 12% of such respondents said they have 20 or fewer managers.

2026 Adjustments

Nearly three-quarters of respondents (72%) said their firm plans to adjust its PE commitment size and/or the number of manager relationships in 2026. A common theme among the respondents who provided comments was the desire to focus on managers with the best long-term IRR, according to ILPA.

Of the respondents who anticipate adjustments, about half said they plan to increase the number of managers, while just over one-fifth plan to reduce the number. Similarly, nearly half of the respondents who said they plan to adjust their PE programs plan to increase commitment sizes, while one-fifth plan to decrease them. “I think that all things being equal, LPs would like their annual PE allocations to remain static or progress on a planned trajectory to create and foster predictability,” Richman said. “But institutional investors are forced to react to a choppy market.”

In light of the relatively subdued exit activity and distributions in the PE space, it was encouraging – and somewhat surprising – that a majority of LPs actually plan to increase allocations to PE and private assets, as well as the number of managers they expect to work with, Sabin opined. Institutional LPs are in a position to efficiently manage multiple manager relationships given that they have “more professional staff and consultants, as well as increased automation of certain diligence procedures,” he noted.

One factor that may be driving LPs to increase the number of managers to which they allocate may be the perception that “there’s more alpha to be had in the middle market and the lower middle market than there is at the top of the market,” Richman suggested. “If you’re investing in smaller managers, you need more of them so that the math works and you can avoid overconcentration.”

Staffing

Seventy-one percent of respondents from both small and mid-size firms have up to three front office staff members managing PE investments. Most of the rest have from four to six such staff members. At the other end of the spectrum, 69% of respondents from large firms reported having at least four such staff members, including 24% that have 13 or more. Just 37% of respondents, including nearly half of respondents from large firms, said their firm plans to hire additional investment staff in the coming year.

Negotiating Leverage and Key Terms

Just over half of respondents said they have more negotiating leverage with GPs than they had a year ago – but most said they have only “somewhat more” leverage, not “significantly more.” A small percentage said they have somewhat less or significantly less leverage. Large firms apparently fare better than small and mid-size ones in negotiations. Sixty-four percent of respondents from large firms reported increased leverage, versus just 38% and 44%, respectively, of those from small and mid-size firms.

Issues With GP Counsel

Respondents identified two primary factors affecting their negotiating leverage. First, top-performing managers are in high demand, giving them greater leverage. Second, there is a “strong misalignment between LPs and their GP external counsel counterparts,” noted ILPA.

“Whether fair or not, GP counsel is the face of the legal diligence process for the GP and the fund, and is the character in the story that is routinely declining the requests of LPs,” Richman remarked. Due to consolidation in the industry, a single law firm might represent a dozen or more of the GPs with which an LP invests. Consequently, by way of example, if an LP requests side letter provisions from one manager, the GP counsel may know that the LP already conceded that point on a different investment. That dynamic has always existed but, at least anecdotally, seems to have advanced in recent years.

Additionally, the amount that even the largest institutional investors can spend on negotiating fund documents “pales in comparison to what a GP can incur as organizational expenses,” Richman continued. “A GP might have a $5‑million organizational expense cap for a $1‑billion fund, while an LP’s legal diligence budget for that same fund will be far less.”

See “Rethinking the Relationship Between GCs and Outside Counsel” (Jan. 22, 2026).

Key Person Provisions, Waterfalls and GP Duties

ILPA asked respondents how they fare in negotiating more than a dozen deal terms, including which provisions they challenge most often and the concessions GPs agree to most often. The terms respondents most frequently challenge, and the corresponding frequency with which they obtain concessions, include:

• key person provisions (61% challenge, but only 37% obtain a concession);
• distribution waterfalls (43% challenge / 8% concession);
• GP standard of care and fiduciary duties (36% challenge / 19% concession);
• GP rights, duties and investment limitations (33% challenge / 20% concession); and
• most favored nations provisions (28% challenge / 48% concession).

Negotiations over key person terms often involve the amount of time a key person must devote to a fund, Richman noted. LPs typically expect such persons to devote “substantially all of their business time” to the fund. Negotiations over waterfalls often involve what constitutes a realization, particularly debt-financed distributions. The GP’s fiduciary duty and standard of care is a perpetual concern, as many LPs are themselves fiduciaries for the persons that ultimately benefit from the investment proceeds, he observed.

The prevalence of these issues depends in part on the particular managers involved. “For instance, key person discussions are often more pronounced in funds managed by ‘boutique’ managers owned by a small group of founders that are actively involved in business,” Sabin said. On the other hand, “in funds sponsored by large multi-product publicly traded managers, disagreement is often around how to manage conflicts (e.g., allocation of investment opportunities) in light of the managers’ multiple products and broad range of activities.”

See our two-part series on key person provisions: “Drafting Effective Key Person Provisions” (Jul. 10, 2025); and “Grappling With a Key Person Event” (Jul. 24, 2025).

GP Behavior

ILPA asked about how GPs’ behavior had changed over the past year on key areas of alignment, including:

• fees;
• economic terms;
• governance terms;
• reporting;
• conflicts of interest;
• valuations; and
• communications and engagement.

Respondents overwhelmingly reported that GP behavior had remained the same or improved. Improvement was most notable in communications and engagement, where 49% of respondents reported improvement. At the other end of the spectrum, just 12% and 14% of respondents, respectively, said that behavior on conflicts or valuations had improved.

There were, however, three areas with a notable rise in the proportion of respondents who said GP behavior had worsened compared with ILPA’s 2024 study:

• conflicts of interest (32%, up from 21% in 2024);
• valuation (17%, up from 9%); and
• governance terms (19%, up from 5%).

Notably, continuation vehicles pose significant concerns around valuation and conflicts of interest. For example, when an asset is removed from a fund, any subsequent asset appreciation is no longer available to satisfy a clawback triggered by other fund investments. That is “a very big conflict of interest,” Richman stressed. Another concern is GPs “using continuation fund exits to essentially dispose of the asset to itself to improve the GP’s track record,” he added.

Another concern is when “LPs feel like they’re being forced into one option or another,” Richman continued. In some cases, LPs may not be given sufficient time to evaluate the transaction before making a roll-sell election. In others, the LP may not be in a position to make an additional commitment required by the continuation fund. “As continuation funds continue to proliferate, these issues are not going away,” he cautioned.

Finally, a significant conflict arises when a GP decides whether to sell an asset or use the asset as collateral for a debt-financed distribution, Richman continued. If the two options would result in a different economic outcome for the GP (e.g., an acceleration of carried interest), the GP may (intentionally or subconsciously) allow those disparate outcomes to influence its decision making.

See “Managing Inherent GP and Counsel Conflicts of Interest in GP‑Led Secondaries” (Apr. 16, 2026); and our two-part series on continuation vehicles: “Practical Tips and Pitfalls for LPs in Continuation Vehicles” (Jun. 26, 2025); and “LP Diligence Guidance and Election Options” (Jul. 10, 2025).

Co‑Investments

Respondents noted that co‑investment rights are usually “must haves” when negotiating with GPs. “Fifteen to twenty years ago, co‑investment opportunities were an ‘also have.’ I think now co‑investment rights are table stakes for many investors,” Richman said. LPs have enhanced their investment and operational due diligence processes to be able to consider co‑investments.

Successful sponsors typically do not grant pro rata or other “formulaic” co‑investment rights to all fund investors, according to Sabin. “However, larger sophisticated LPs often negotiate some form of co‑investment rights in practice, for instance, by having dedicated ‘sidecar’ vehicles that invest alongside the fund in oversized investment opportunities.”

Study Findings

In its study, ILPA found that nearly three-quarters of respondents’ firms co‑invest, including 32% that do so opportunistically; 26% that have dedicated resources and/or a target allocation; and 16% that invest through a third party. Large firms account for nearly two-thirds of the firms with dedicated co‑investment resources. One-third of respondents said their firms co‑invest outside of manager relationships.

Two factors may explain the high proportion of respondent LPs that said they co‑invest, Sabin explained. First, because ILPA members are among the more sophisticated institutional investors, they may be more likely to co‑invest than other investors in the broader LP base, he reasoned. Second, an LP that answered “yes” may only co‑invest sporadically and may skip most co‑investment opportunities. “In my experience, even LPs that express interest in co‑investment opportunities and have sponsors acknowledge such interest in side letters often lack internal capacity and staff to review and execute on such opportunities,” he shared.

Drivers of Co‑Investment Allocations

Two important drivers of GPs’ willingness to confer co‑investment opportunities to LPs are ticket size and the investor’s relationship with the manager. On the latter point, Richman noted that managers may also take into account their history with investors and whether “they’re going to try to negotiate the co‑investment documents, which would take further time and resource allocation.”

Another driver that informs GPs’ allocation of co‑investments is ease of contracting, Richman continued. Some institutional investors only make investment decisions on a quarterly basis, whereas others may be able to commit capital overnight. GPs are likely to prefer the latter, as co‑investments often arise and are executed on an accelerated timeline.

To override some of the hurdles around speed and ease of transacting, some LPs establish single investor funds or sidecar vehicles to facilitate co‑investments, Richman observed. Although those vehicles do create the opportunity for significantly enhanced efficiency, they are costly to establish and, once the LP has incurred that expense, there is no guarantee the manager will offer a co‑investment.

See our two-part series on co‑investment equity commitment letters: “Rising Prominence and Role” (May 29, 2025); and “Key Terms and Negotiating Positions” (Jun. 12, 2025); and our two-part co‑investment series: “Key Drivers, Unique Fund Structures and Alternative Approaches” (Aug. 22, 2024); and “Offering Process, Key Fund Terms and Regulatory Considerations” (Sep. 5, 2024).

LPAC Seats

ILPA’s study found that another LP “must have” is a seat on a fund’s LP advisory committee (LPAC). “It is fairly typical for either larger sophisticated institutional LPs or strategic relationships of sponsors to have LPAC seats,” Sabin said. “However, LPAC seats are naturally limited, as LPACs with more than 15‑20 voting members – which is often the size for large or ‘mega’ funds – do not function as well as smaller ones,” he clarified. Although some LPAC members are appointed by sponsors, most seats are granted to investors that negotiate for those seats in their side letters.

See “The Case for Independent LPAC Members” (Oct. 3, 2024).

Although private fund managers typically do not interact directly with retail investors, they may have broker-dealer affiliates that do or may choose to offer a registered product. Also, future changes to the definition of accredited investor and/or the Regulation D private offering regime could increase managers’ direct access to such investors. As both regulators and private fund managers warm to the idea of making private market investments accessible to retail investors, managers face new and unique challenges that they will need to address in their respective compliance programs.

A program presented by the National Society of Compliance Professionals examined due diligence requirements – and the associated regulatory concerns – when offering investment products to retail investors, including the fiduciary obligation to ensure that investments are appropriate for each client. The program featured Miriam Lefkowitz, a compliance consultant and securities regulatory attorney; Ana D. Petrovic, director at Kroll; and James Sommerfield, Jr., senior compliance officer and principal at Wintrust Wealth Management. This article synthesizes their insights.

See our two-part series on retail distribution platforms: “Growing Popularity, Numerous Benefits and Operational Obstacles” (Sep. 4, 2025); and “Selection Criteria, Due Diligence Processes and Potential Pitfalls” (Sep. 18, 2025).

Regulation Best Interest and Fiduciary Duty

The “suitability” requirement for broker recommendations has been around since the National Association of Securities Dealers’ formation in the 1950s. The SEC’s adoption of Regulation Best Interest (Reg BI) in 2020, however, was a sea change for brokers.

The “care” obligation of Reg BI requires a broker to have a reasonable basis for believing a recommendation is in the customer’s best interest. Fulfilling that obligation includes exercising “reasonable diligence” to understand the potential risks, rewards and costs associated with a particular product recommendation and having a reasonable basis to believe that:

• recommending that product could be in the best interest of at least some retail customers; and
• if so, whether it is in the best interest of that specific retail customer, taking into account the customer’s specific investment profile and other considerations.

Reasonable diligence may include, for example:

• considering reasonably available alternatives for a particular customer as part of customer-specific suitability analysis;
• ensuring compliance with the “disclosure” obligation of Reg BI, including as to fees, costs and the types of services provided to the retail customer; and
• satisfying the “conflict of interest” requirement, especially when recommending proprietary products.

Due diligence is also a component of an adviser’s fiduciary duty. The duties of brokers and advisers have converged over the years, especially as to onboarding new products or modifying existing products.

See “SEC 2026 Examination Priorities Highlight Classic Compliance Issues, Retailization Efforts and AI Oversight” (Jan. 8, 2026); and “SEC Chair Defends Regulation Best Interest and Investment Adviser Fiduciary Duty” (Sep. 10, 2019).

Regulatory Concerns

The SEC assesses whether firms adapt appropriately in market dislocation events and periods of excess volatility. The agency expects advisers to be proactive and examine products periodically to determine whether they still make sense.

Often, investor complaints increase when performance shifts, which advisers can mitigate by communicating carefully with their clients. “Something as simple as saying ‘market volatility may occur’ versus ‘we are in volatile times’ could make all the difference from a regulatory perspective,” noted one of the panelists.

See “What ‘Back to Basics’ Under Chair Atkins Means for SEC’s Division of Enforcement” (Feb. 5, 2026); and “What to Expect on SEC Examinations Under the New Administration” (Sep. 18, 2025).

Conflicts of Interest

“Conflicts” is a favorite word of regulators – and the more complex a product, the greater the chance of conflicts, a panelist reasoned. CCOs have an important role in flagging potential conflicts. To address those risks outside of due diligence, some firms perform an annual conflicts review that scrutinizes all their product offerings and activities; looks for potential conflicts; and ensures there are processes for mitigating those conflicts.

It is also helpful for a firm to develop a tool that explains all of the incentives associated with the products representatives are offering. It can incorporate information learned during the due diligence process and can be used to inform the firm’s compliance and supervision programs, which would make them more robust and defensible.

See “Managing Conflicts and Developing Effective Compliance Policies and Procedures” (Oct. 19, 2023).

Poor Governance

A common due diligence weakness is poor governance. It is important to involve all relevant stakeholders to determine how a product functions and how it will be used. The CCO should be at the table as part of that process, as firms get into trouble when business functions get excited about a new product and push it through without legal and compliance input – leaving the latter to defend it later. Even if that occurs, however, the compliance function can still do supervisory training and testing to assess the product and whether changes are needed. Using a third party to assess the product is also a good practice.

See “Improving Compliance Programs With Gap Analysis and Risk Assessments” (Dec. 14, 2023); and our three-part series on tailoring a compliance program: “Why Fund Managers Should Customize” (Aug. 24, 2021); “What Fund Managers Should Consider” (Aug. 31, 2021); and “When Fund Managers Should Review and Update” (Sep. 14, 2021).

Inadequate Documentation

Many regulatory requirements are principles-based and offer firms flexibility for determining how much to document. Many firms see documentation as extra “homework.” Still, “keep in mind that if you’re doing a good job, you want to give yourself credit for the good work that you’re doing,” suggested a panelist. More importantly, documentation can protect a firm. It can take years for a matter to get to enforcement, and the people involved in an incident may not be around to explain the firm’s actions at the time.

Firms should also document when they reject products. “Maintaining records of all the things you didn’t do demonstrates that you don’t just fall in love with every product that crosses your path,” explained a panelist.

See “SEC Signals Continued Willingness to Pursue Technical Violations With No Apparent Investor Harm” (Oct. 16, 2025); and “Loose Practices and Imprecise Recordkeeping Prompt SEC Scrutiny, Even When Investors Are Unharmed” (Nov. 16, 2023).

Building a Due Diligence Program

There is no one-size-fits-all approach to due diligence. Whoever makes the decision to offer an investment product must have a thorough understanding of the product to ensure it meets the reasonable basis suitability standard. A committee structure is usually preferable. In addition to compliance personnel, such a committee may include sales management, senior leadership and other stakeholders with product knowledge. The committee can make decisions about the types of products the firm wants to offer, consider any training that needs to be implemented and mitigate any attendant conflicts of interest. Given that products may change and evolve, due diligence must be ongoing.

The extent to which a product is vetted will depend in part on its complexity. Some products are difficult for brokers to understand, which is worrisome given that firms rely on those representatives to educate prospective investors. If those individuals fail to adequately educate investors, firms could be open to claims from investors that they did not understand what they were buying.

Documentation

Firms must document their due diligence process carefully. To that end, it can be helpful to develop a template form for due diligence review. The form can reflect that a firm conducted due diligence and had a reasonable basis for believing the product was appropriate for at least some clients. A product’s complexity and the availability of less costly or less complex alternatives that will do the same thing are important considerations.

After a product is approved for sale, each representative must still determine whether it is appropriate for specific clients. A separate form for customer-specific due diligence of a particular product can be a valuable tool for complex products. For example, a form for structured products might cover, in plain English, the risks associated with the product, how it functions and how it generates income. The form can help document that an investment was appropriate for the customer and can counter any claim by the customer that it did not understand the product.

See “Checklists to Help Fund Managers Comply With SEC Recordkeeping Requirements” (Sep. 4, 2025).

Ongoing Due Diligence

Initial due diligence includes collecting relevant information and making the initial determination that a product is suitable for at least some customers. Once a product is onboarded, the firm must continue to monitor for any changes to the product. At least annually, a firm should review its product offerings and whether to continue offering each product.

Customer complaints are a good litmus test because they will reflect whether a product was a good fit. A customer may have misunderstood a product’s liquidity or how it performed over time. A firm that starts to receive a higher volume of complaints about a particular product should immediately reevaluate the product.

Firms should also check how often their representatives are offering particular products. For example, if a product is offered more than the firm expected, it should consider whether it is because it is simply a better product than expected or whether there may be financial incentives for recommending it.

Unlike brokers, annual product reviews generally are insufficient for advisers. A broker’s duty occurs at the point of making a recommendation. In contrast, an adviser’s duty generally covers the duration of an investment, particularly if the adviser is being paid an asset management fee. Further, an adviser must also ensure it operates in accordance with the disclosures in its Form ADV. An adviser will be held to the standards it sets in its Form ADV – even if such standards are not required by regulation.

To be clear, the ongoing duty owed by advisers does not mean that daily due diligence is required. It does mean, however, that an adviser must be attentive to changes in products that the adviser recommended or that the adviser agreed to monitor. To keep abreast of product changes, advisers should have contacts at product providers and periodically take the pulse of the marketplace. They should establish lines of communication and processes to address issues as they arise, and should also set triggers to review products (e.g., change in leadership at a company or a significant change in a commodity price).

Due Diligence Vendors

Firms can rely on third-party due diligence to fulfil their duties. Due diligence vendors can help streamline review processes, with firms often obtaining data from firms like Bloomberg and Morningstar. Some also use due diligence vendors to analyze their products (e.g., private placement memoranda).

Given how many products are available and how quickly they evolve, it is impractical for a small firm to have an in-house expert to review all products. Firms that use vendors, however, must not simply take the reports and put them in a file. “Vendor reports can be useful, but they are not a replacement for some level of understanding of the product” – especially when a report contains cautionary statements or open questions, advised a panelist. A firm should review reports delivered by vendors and address any open questions based on its own assessment and risk tolerance. A firm is ultimately responsible for what it recommends and cannot delegate that responsibility to a third party.

“Being involved from the outset is very important,” stressed a panelist. A firm can get into trouble if it hands off a project to a third party without providing any direction. The firm should identify the issues and questions it wants the vendor to address.

See “Managing Risks Associated With Outsourcing” (Nov. 2, 2023).

Third‑Party Advisers and New Representatives

A firm may desire to offer the services of third-party advisers with strategies that the firm knows little about. “There always needs to be a level of due diligence in those situations, but it isn’t necessarily at the specific investment level,” clarified a panelist. The due diligence at that point is conducted on the manager – not the manager’s underlying strategy. It could include reviewing the manager’s Form ADV, business continuity plan, track record and whether its operations are consistent with its disclosures.

For example, a firm may choose not to offer a product from a manager because the manager is too new to the market and lacks a sufficient track record. The complexity of the product is another important consideration. An additional concern is whether the third-party manager has been associated with any individuals who have had regulatory issues.

Similarly, when a firm brings in new representatives, the firm may not have expertise in the products the representative recommends and may not know how well the representative understands such products. That risk is greater for advisers than for brokers because of advisers’ ongoing duty to understand products.

Risk Mitigation Factors

CCO Liability

CCOs and compliance counsel should be part of the due diligence committee and process but not voting members. A CCO is not expected to be a product expert. “Compliance is an expert in compliance,” emphasized a panelist. The CCO’s involvement can help ensure the firm conducted suitable due diligence and came to an answer with an appropriate comfort level, but does not factor into the firm’s decision whether or not to offer a product. To avoid liability for the committee’s noncompliance-related decisions, CCOs can protect themselves by documenting their role in the process.

See “SEC Commissioner Uyeda and Enforcement Director Grewal Discuss Compliance Challenges and CCO Liability” (Jan. 25, 2024).

Remediation

“The fact that a product blows up is not necessarily an indication that it was a problem,” cautioned a panelist. A firm should not ignore that result, however, even if it is not subject to any Reg BI duties at the relevant time. Instead, the firm should consider whether it could or should have known about the issue.

Sometimes compliance is not involved at the outset of a product launch or does not receive all the information it would have liked to obtain. “Performing a prompt assessment is a critical component of governance,” said a panelist. If an issue arises, the firm should consider whether to involve counsel and preserve privilege, which will depend in part on the nature of the incident and the risk to the firm. Additionally, cooperation credit may be available to a firm that provides substantial assistance in an SEC investigation. If a firm discovers an issue with its due diligence when investigating the incident, it may help the firm to be proactive about finding the source of the problem and fixing it.

One of the challenges faced by the SEC’s Division of Enforcement staff is deciding which matters to pursue. “Unfortunately, there are always more tips, complaints and referrals than there are Commission staff to investigate and bring cases,” stated a panelist. A key question is whether there was harm and, if so, whether it was likely to be repeated. If a firm discovers an issue and remediates it, regulators will be less interested in the matter. Many firms believe that if they fix an issue, it will be seen as an admission of wrongdoing – but firms should never shy away from making improvements. “The standard for compliance isn’t perfection; it’s reasonableness,” emphasized a panelist.

See our two-part series on SEC cooperation credit: “Examining HeadSpin As a Framework for Optimal Remediation Measures” (Jun. 1, 2023); and “Inherent Obstacles to Fund Managers Receiving Full Credit” (Jun. 15, 2023).

On February 19, 2026, Lowenstein Sandler issued the results of its sixth annual alternative data study (Report). “Our survey suggests that alternative data has become a foundational element of investment research,” Scott Moss, a Lowenstein Sandler partner and co-author of the Report, told the Private Equity Law Report. The growth may be due to increasing integration of artificial intelligence (AI). Although AI accelerates firms’ ability to generate insights and uncover alpha, it increases the need for strong governance, model risk oversight and clear data provenance, Moss noted. Firms face “a more complex commercial and governance environment with higher costs, tighter licensing terms and greater restrictions on AI-related data usage, particularly for model training,” he added.

The latest survey examined the growing uptake of alternative data and AI; how firms are applying AI to alternative data; data sources; key risks and concerns; and budgeting. This article parses the Report, with additional commentary from Moss and the Report’s other co-authors, Lowenstein Sandler partner Boris Liberman and counsel George Danenhauer.

For our coverage of a previous Lowenstein Sandler survey, see “Driven by AI, Private Funds’ Use of Alternative Data Continues to Grow, Survey Finds” (May 30, 2024).

Survey Demographics

Lowenstein Sandler conducted an online survey in November and December 2025. Consistent with past surveys, there were 107 respondents from hedge funds (41%), PE firms (39%) and venture capital firms (20%). Twenty-eight percent of respondents were C‑level executives. Other significant cohorts included portfolio managers (21%) and managing directors (13%).

Respondents’ firms were relatively evenly divided among those with more than 500 employees (33%); those with from 201 to 500 (38%); and those with 51 to 200 (26%). A majority of firms (61%) reported having between $500 million and $5 billion assets under management (AUM). Most of the rest (28%) have more than $5 billion AUM. Just 11% reported less than $500 million AUM.

Broad Uptake of Alternative Data

Ninety percent of respondents said they currently use alternative data, up from 67% and 62%, respectively, in 2024 and 2023. Moreover, 81% said they had increased their usage over the past 18 months. Just 5% said their usage decreased during that period.

The huge year-over-year jump in use of alternative data may be explained by “AI’s emergence as a catalyst for exploiting alternative data,” noted Liberman. “Advances in large language models and machine learning have made unconventional sources, such as satellite imagery and credit card transactions, potentially more valuable. AI has enabled the harvesting and analysis of large datasets, allowing investors to extract more value and make new connections.”

See “Limited AI and Alternative Data Adoption for Legal and Compliance Efforts, According to Survey” (May 1, 2025).

Widespread Integration of AI

All Firms Using AI for Investment Processes

All respondents said they are currently using AI systems for investment research, portfolio optimization and/or trading (collectively, investment processes) either to a large extent (53%) or a moderate extent (47%). No respondent indicated that the respondent’s firm does not use AI at all for investment processes or uses it only to a small extent. Moreover, 94% of the respondents that currently use alternative data use it in combination with fundamental analysis when making investment decisions.

The five most common areas in which respondents expect to deploy AI in the coming year include:

1. summarizing research and materials (78%);
2. investment processes (74%);
3. investor relations (69%);
4. employee supervision/monitoring (65%); and
5. automating routine tasks (61%).

More than half of respondents also plan to use AI for HR, marketing, and/or legal and compliance.

Uptake of AI has increased dramatically in the past two years. For example, in the 2023 survey, just 16% of respondents said they were using AI on a fully operational basis, and half were using it on an evaluative basis, noted Moss. By 2024, 61% of respondents were using AI for investment processes. All respondents now use AI in investment processes at least to a moderate extent. “The trajectory indicates a clear progression from experimental/evaluative use to mainstream adoption to universal adoption at scale and represents a fundamental transformation in how investment firms operate, with AI becoming integral to many research and trading activities,” he observed.

See “Benchmarking Fund Managers’ Adoption and Governance of Generative AI” (Jan. 8, 2026).

Many Firms Developing Custom AI Systems

“In 2025, bespoke AI usage became much more widespread across all firm types,” said Moss. Virtually all respondents said their firms are using custom AI systems for their investment processes, including 43% using such systems to a large extent and 46% using them to a moderate extent. Just 1% are not using them at all.

“Bespoke AI usage has expanded significantly, particularly with hedge funds,” stressed Moss. Notably, in 2024, no hedge fund respondents said they were using custom AI systems for investment processes. In the latest survey, 93% are using such systems to a large or moderate extent.

Respondents overwhelmingly use proprietary data for training their custom AI systems, including internal market data, records and research (90%); proprietary market data from third parties (82%); and proprietary alternative data from third parties (72%). Additionally, 56% use web scraping.

Respondents indicated that they are accepting various levels of AI licensing restrictions, according to Moss. In that regard:

• 24% accept restrictions on using AI with licensed data;
• 32% accept restrictions on training AI models; and
• 44% accept restrictions on training AI models outside their firms.

See “Benchmarking AI Uptake by Compliance Functions” (Feb. 19, 2026).

Alternative Data Vendors Adopting AI

Some alternative data providers are adding AI functionality to their products, notes the Report. Nearly one-quarter of respondents (22%) said AI was, for the most part, inherent in their providers’ products. Most of the rest (72%) reported seeing a mix of inherent AI functionality and “plug-in” AI options. Unsurprisingly, 81% of respondents said the cost of alternative data products with AI functionality had increased.

See “Managing Risks Associated With Outsourcing” (Nov. 2, 2023).

Diverse Data Sources

More than three-quarters of respondents (77%) gather alternative data both in-house and from third-party vendors. Fourteen percent use only vendors. The remaining 9% gather it in-house.

The most common sources of alternative data, cited by at least half of respondents, include social media (59%), web scraping (56%) and cloud platforms (55%). More than 40% also use consumer transactions, app usage data, geolocation data, scientific research and AI-derived synthetic data. There were modest year-over-year declines in the proportion of respondents using most sources of alternative data. On the other hand, there was a significant jump in the proportion using satellite imagery – from 26% last year to 35% this year. Of the respondents that monitor social media, more than three-fifths monitor Facebook, LinkedIn, Instagram and/or X. “Firms are becoming more selective, focusing on fewer and more reliable sources, rather than casting a wide net,” noted Danenhauer.

Notably, the proportion of respondents using AI-derived synthetic data fell from 58% in 2024 to 42% in 2025. Several factors may have contributed to the drop, including firms’ increasingly developing custom AI systems, being more selective about data sources and having concerns over data provenance, explained Liberman. “The key to driving alpha may not be tied to how much data you interpret but how well you interpret reliable data,” he remarked. Additionally, “firms are increasingly focused on having a clear data provenance strategy and auditable decisions, which may be making them more cautious about using AI-derived synthetic data whose provenance is less clear,” he said.

Widespread Adoption of Alternative Data and AI Policies

Four-fifths of respondents said their firms have a formal written alternative data policy. An additional 16% have an informal policy.

Most respondents (86%) have a specific formal policy for using AI for investment processes. Interestingly, just 40% think their competitors have such a policy.

See “Driven by AI, Private Funds’ Use of Alternative Data Continues to Grow, Survey Finds” (May 30, 2024).

Concerns Over Alternative Data and AI

Respondents’ most common “major concerns” when using alternative data are data ownership and privacy issues (39%); vendor-related vetting, costs and data quality issues (32%); and risk of acquiring material nonpublic information (MNPI) (30%). More than one-quarter also identified data security, third-party cybersecurity risks and regulatory scrutiny. Roughly one-fifth cited data processing and quality issues. Fewer cited inadequate staffing, skills and/or technology. Just 10% cited an increased compliance burden.

Respondents cited many of the same concerns regarding their purchase and use of AI. More than one-third cited data ownership and privacy issues (42%); third-party cybersecurity risks (41%); vendor-related vetting, costs and data quality issues (40%); data security (38%); and “lack of confidence/trust in deriving value from current AI systems” (36%). Nearly one-third cited the risk of acquiring MNPI. Roughly one-quarter cited lack of staffing and skills; increasing compliance burdens; and/or increasing regulatory scrutiny.

Several findings “suggest firms may be more confident about their ability to manage AI-related risks than the complexity of the environment might warrant or that practical concerns about data privacy and cybersecurity take precedence over capability and regulatory concerns,” cautioned Moss. The relatively low proportion of respondents concerned about AI’s value was surprising. “Given the relative newness of AI in investment applications, one might expect higher skepticism,” he observed.

Similarly, just 18% of respondents expressed concern over rights to use alternative data with AI or other software tools, “which seems low given the tighter licensing restrictions being imposed by vendors,” continued Moss. Additionally, notwithstanding “significant regulatory attention to AI in financial services,” increasing regulatory scrutiny was not a top concern. Finally, despite a “well-documented AI talent shortage across industries,” just 23% of respondents are concerned about a shortage of staff with AI skills, he added.

See “Unique Issues With Fully Remote OCIE Exams, and How Sponsors Can Withstand the Agency’s Focus on Alternative Data (Part One of Two)” (Dec. 8, 2020).

Alternative Data and AI Budgets

Most respondents (89%) expect their alternative data budget to increase this year. Two-thirds expect it to increase either from 11% to 25% (35%) or from 26% to 50% (31%). Just 16% expect it to increase by up to 10%. The remaining 18% expect it to increase more than 50%.

Similarly, virtually all respondents (93%) expect their AI budget to increase this year. Here, too, about two-thirds expect it to increase either from 11% to 25% (33%) or from 26% to 50% (30%). Eighteen percent expect it to increase up to 10%, while the remaining 18% expect it to increase more than 50%.

See our two-part series on AI in private funds: “Emerging AI Technology and Valuable Legal- and Compliance‑Related Applications” (Nov. 16, 2023); and “Challenges, Best Practices for Implementation and the Road Ahead” (Nov. 30, 2023).

Rachel X. Shepardson has joined Paul Hastings as a partner in its investment funds and private capital practice in New York. She represents fund managers across a variety of investment strategies, including PE, credit, real estate and infrastructure funds.

For insights from Paul Hastings, see “SEC 2026 Examination Priorities Highlight Classic Compliance Issues, Retailization Efforts and AI Oversight” (Jan. 8, 2026); and “Growing Popularity, Numerous Benefits and Operational Obstacles of Retail Distribution Platforms (Part One of Two)” (Sep. 4, 2025).

Shepardson advises fund managers on the formation of a broad range of fund structures, including open-end and closed-end funds; evergreen structures; separately managed accounts; and co‑investment vehicles. She routinely counsels clients on upper-tier matters such as seeding arrangements; management company M&A and GP stake transactions; and related regulatory considerations.

Most recently, Shepardson was a partner at Paul Weiss.

See “Key Catalysts Behind the Emerging Trend of PE Spinouts (Part One of Three)” (Oct. 30, 2025); and “Planting a Seed or Securing an Anchor: Finding Success As an Emerging Manager” (Nov. 14, 2024).