Will Private Credit Thrive Inside an ETF?
ETF issuers are trying to build private investments for the masses.
As Wall Street innovation wrestles to put private credit investments into the hands of retail investors, the ETF looks like the vehicle of choice.
Last month State Street Global Advisors and Apollo Global Management announced a partnership designed to expand investor access to the kinds of private markets that are typically limited to the wealthiest individuals and institutions.
That effort joins such notables as BlackRock in trying to solve the riddle of placing traditionally illiquid investments inside an ETF wrapper that has been built on a foundation of liquidity.
“We would like to see more retail investors gain access to the private credit space, and if the investment industry can create a product to accomplish that, we think it would be a positive advancement,” said Joseph Spada, private wealth advisor at Summit Financial in Parsippany, N.J.
“However, liquidity will be a large hurdle they will have to overcome, especially during market cycles that exert stress on the private credit space,” he added.
Retail Access to Private Markets
While the idea of providing retail investors access to private markets might seem like a next logical step for an ETF industry that seemingly knows no limits when it comes to innovation, the sticking point for now comes down to the lack of liquidity of the underlying investments.
Like a lot of private and alternative investments, the reduced liquidity is typically the key ingredient to the investment premium, often referred to as the illiquidity premium.
“The number one challenge is putting an inherently illiquid asset class in a liquid vehicle,” said Ryan Jackson, senior manager research analyst at Morningstar.
“Apollo has agreed to provide the liquidity to back the ETF, but there are still question marks about how effectively that will work for fundholders,” he added. “This is uncharted territory for ETFs and comes with a lot of uncertainty.”
Rick Wedell, president and chief investment officer at RFG Advisory in Birmingham, Ala., said putting private investments inside an ETF “feels like a miss-match, and the problems it creates in terms of constructing an ETF are numerous.”
Liquidity for Loans?
Private credit is a generic term for investments ranging from direct corporate lending to music royalties and equipment financing, according to Morningstar.
These instruments typically pay a floating-rate coupon, like syndicated bank loans or floating-rate Treasury notes that are commonly found in traditional bond mutual funds. Those floating coupons have softened the impact of rising interest rates in recent years, which helps explain some of the growing interest in private credit.
Against the backdrop, professional investors like Wedell wonder, “Who provides the daily liquidity for the loans” when they are held inside an ETF?
And from a private credit standpoint, Wedell asks, “Why would a borrower want a private credit loan option that then becomes freely traded?”
Matt Malone, head of investment strategy at the private markets platform Opto Investments in New York City, raises the question about the impact of counterparties used to access the private credit investments.
“Although there is limited information available, given the mix of public and private securities and the focus on investment grade, investors are not likely to recognize the full illiquidity premium that makes investing in private credit attractive,” he said. “For most investors, the appeal of private credit is enhanced yield and lower volatility over the long term, and it appears the ETF structure may significantly mute both of those benefits.”
