Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
A flurry of new exchange traded funds is widening retail access to the fast-growing markets for private credit and equity, sparking concerns that these assets are a poor fit for small-scale investors and could prove tough to sell during a crisis.
A private credit ETF launched last month by State Street will hold up to 35 per cent of its portfolio in private debt deals originated by Apollo Global Management. Fixed-income specialist BondBloxx, meanwhile, has applied for regulatory approval for an ETF that could hold up to 80 per cent of its portfolio in private credit.
But the US Securities and Exchange Commission last month raised a number of concerns about the State Street launch, enquiring about plans for mitigating liquidity risk and ensuring accurate pricing.
While the regulator eventually signed off on the fund after State Street provided more information and changed the name, many industry executives remain unconvinced that assets typically bought by investors who can lock up capital for years are suited to daily liquidity fund vehicles that, until now, have mostly held easy-to-sell securities.
“The great appeal of private assets is that allocators can pretend they don’t go up and down,” said Andrew Beer, managing member at DBi, which runs an ETF investing in liquid alternative assets. “How, pray tell, can you maintain this fiction when the ETF trades every day?”
Private equity and private credit, which tend to require long-term commitments and place limits on redemptions, have largely been the preserve of the wealthy and institutional investors such as pension funds and university endowments, which can lock up capital for some time and are often prepared to do without frequent market valuations of their assets.
Issuers in the nascent space hope private assets will prove as popular in the mass market as they have with large institutional investors over the past decade or so, helped by these assets’ strong returns and the prospect of beating the public markets over the long run.
But the lack of an industry standard for how to maintain sufficient liquidity or ensure accurate pricing on a daily basis presents a challenge for regulators.
“I’m still sceptical of whether these are liquid — I would say they’re not,” said Bryan Armour, director of passive strategies research at Morningstar. “How does that work with an ETF that is trading intraday and has ability to create or redeem shares every day?”
Anna Paglia, chief business officer at State Street, defended the launch.
“This fund is operated and managed in full compliance with the 40 Act,” Paglia said, in a reference to the Investment Company Act of 1940, which provides rules for US mutual funds and ETFs.
“Anybody who casts a shadow on that, or implies otherwise, is grossly misinformed,” she added.
The BondBloxx ETF plans to keep 20 per cent of the fund’s assets in cash to withstand investor withdrawals and would give itself the option to temporarily suspend redemptions, a rare occurrence for ETFs. If the fund still needed to raise cash, it would be able to draw on a line of credit to ensure investors could get their money back.
The SEC this month asked for public comments on BondBloxx’s proposal. The timing of its launch is uncertain.
“We think from an investor perspective that [the ETF] would make sense because it offers access to a part of the market they can’t access today,” said Tony Kelly, a co-founder of BondBloxx.
The opening-up of the asset class has raised eyebrows among industry observers who question whether these private assets are being forced into a structure that can only hold up to 15 per cent of their portfolios in illiquid holdings.
In correspondence with the SEC, State Street outlined a plan to deem its Apollo private credit holdings as “less liquid” — a crucial difference from “illiquid” and one that would help the ETF avoid running into the 15 per cent cap.
BondBloxx, meanwhile, plans to launch under the Securities Act of 1933 — a tactic that avoids the 15 per cent cap on illiquid assets but gives less certainty on launch timing.
Morningstar’s Armour said that, according to his analysis, if a fund such as State Street’s needed to reduce private credit from 35 per cent to 15 per cent of its portfolio, it would take at least seven days, without taking into account any inflows or outflows. This analysis assumes that only Apollo would be called on to offload private credit holdings. State Street has told the SEC that it could source bids from other private credit groups.
“It’s always good to challenge the boundaries,” said Noel Archard, global head of ETFs at AllianceBernstein. “As much as I love the structure, is it the right structure for everything?”