By Debbie Carlson
Are private assets and exchange-traded funds more like oil and water, or peanut butter and jelly?
ETFs are cheap, tax-efficient, and transparent. They access niche markets and are easily tradable. Private assets are opaque, expensive, and illiquid, but have grown popular as some believe they may offer superior returns to public markets.
Recent launches by ETF issuers and private asset managers are bringing the rarefied products to a mass audience.
Two actively managed private-credit ETFs that offer direct exposure to smaller-company loans via securitized collateralized loan obligations -- BondBloxx Private Credit CLO (ticker: PCMM) and Virtus SEIX AAA Private Credit CLO $(PCLO)$ -- have launched in December. Another one from State Street Global Advisors and Apollo Asset Management is awaiting Securities and Exchange Commission approval.
CLO ETFs' high yields and cheap costs make them popular with investors, as seen with the $16.5 billion Janus Henderson AAA CLO ETF (JAAA), which has a 6.4% SEC yield and 0.21% annual fee.
The new ETFs own mostly middle-market private credit, while other CLOs may also own broadly syndicated loans; those are technically private-credit loans but have a wider investor base, says Morningstar's Brian Moriarty.
Middle-market CLOs have fewer holdings. George Goudelias, chief investment officer at Virtus SEIX, says private-credit CLOs may own 80 to 100 loans, while a broadly syndicated CLO may contain 200. Private-credit CLOs offer a higher incremental yield of about 0.25 percentage points over broadly syndicated AAA CLOs.
Tony Kelly, co-founder of BondBloxx, says the ETFs offer diversification to a market previously inaccessible to small investors, and their holdings are transparent.
Moriarty agrees securitization is a benefit, but he adds the private-credit CLO market has less breadth and depth than broadly syndicated loan CLOs. ETFs cannot close to new investors, and assets can swell. The new products may not trade as often, and during market stress, their prices could fall further than their net asset value, not unlike what happened to high-yield bond ETFs during the Covid lockdown in March 2020.
The filing from State Street and Apollo has ETF market watchers concerned. Unlike current ETFs that follow a CLO structure, the proposed ETF would own private credit directly, with few disclosures in the filing of how that will work.
ETF industry watchers say they are worried for several reasons. The SEC limits illiquid assets to 15% of an ETF portfolio. In the proposal, Apollo is contracted to act as a liquidity provider, selling credit instruments to the fund in what it calls "intraday executable bids." It will also buy those back those instruments at State Street's request, up to an undefined daily amount. If Apollo cannot provide bids, assets once considered liquid may become illiquid.
That has raised concerns about both self-dealing and potential liquidity mismatches during market stress. Apollo and State Street declined to comment.
Dave Nadig, an independent ETF industry watcher, suspects the filing is trying to get around the public market rules of transparency and price discovery. If approved, this new ETF structure could inspire copycat funds as issuers look for new revenue.
Jay Sammons, private markets portfolio manager at Gratus Capital, says he doesn't understand why investors need something like a private-credit ETF, since the point of private assets is they're supposed to be long-term holdings that offer higher returns.
"There's a big push, especially in high-net worth, ultra-high-net-worth channels, to increase allocation to this risk bucket, whereas I'm not sure a lot of investors yet really grasp the credit quality they're assuming, or the credit risk they're assuming," he says.
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December 24, 2024 01:00 ET (06:00 GMT)
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