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Investors are dumping publicly traded private credit funds as they take losses on bad loans and concerns intensify that AI will wreak havoc on the software companies they have financed.
The vehicles, known as business development companies, are trading at 82 per cent of their asset value, their biggest discount since late 2022 and a sign that investors believe the funds will face further pain, according to FT calculations based on the S&P BDC index.
The slide in value of these BDCs, which changed hands above 100 cents on the dollar last September, has cast a shadow on the broader $2tn private credit industry, adding to pressure on unlisted private credit funds that are facing an uptick in redemptions.
Those vehicles, known as semi-liquid funds, have been an engine of growth for giant private investment firms, including Blackstone, Ares Management and Blue Owl, providing lucrative management fees and helping quadruple assets in BDCs since the end of 2020.
The slump in BDCs kicked off last September as the Federal Reserve began lowering interest rates, weighing on the returns offered by loans, which generally move in tandem with broader borrowing costs. The high-profile collapse of two auto companies — First Brands and Tricolor — that month fanned fears about corporate credit quality and underwriting standards.
The sell-off in BDCs has reaccelerated following a spurt of write-offs at several large funds over the past two weeks, including vehicles managed by KKR, BlackRock, New Mountain, Apollo Global and Blackstone as they wrote down the value of loans they hold. Funds managed by BlackRock, KKR, Morgan Stanley and Apollo also cut dividends on their vehicles.
Many affluent retail investors were drawn to the space by the high dividends on offer, with annualised total returns eclipsing 8 per cent over the past decade, according to S&P Global.
The recent cuts as well as asset sales at some funds “reignited credit-cycle fears” across private credit, said Paul Johnson, an analyst at KBW.
“A lot has stacked against the space and it probably remains that way . . . until they have worked through these dividend cuts,” he said. Johnson added he suspected the steep discounts on publicly listed BDCs and the recent scrutiny on the industry would weigh on new allocations to private BDCs.
Losses in recent days have been spread across a smattering of corporate loans, including one to Medallia, a software company bought by technology-focused private equity firm Thoma Bravo for $6.4bn in 2022. Publicly listed funds managed by BlackRock and KKR both lent money to Medallia.
BlackRock’s fund, known as BlackRock TCP Capital, in late January slashed the value of loans it held, writing down its assets by 19 per cent. Many of its problem loans were made to companies that sold products on Amazon, including Razor Group and SellerX, as well as the education technology company Edmentum.
“All of these positions were underwritten in a significantly lower base rate environment and have faced challenges adjusting to sustained higher interest rates,” Phil Tseng, the chief executive of the BlackRock vehicle, said on a call with analysts last week.
While a senior executive at a rival said the BlackRock fund “isn’t representative of the broader direct lending market”, its troubles have nonetheless reverberated through the industry, fraying investor nerves.
Johnson noted that while the fund had been “stressed” for years, “severe underperformance of a BDC affiliated with a leading asset manager is hard to ignore these days”.
BlackRock’s fund, which has posted a total return of minus 43 per cent over the past year, is trading at a discount of more than 50 per cent to its net asset value. Apollo’s vehicle, known as MidCap Financial Investment, is priced at a 34 per cent discount to its fund value, while KKR’s, FS KKR Capital, trades with a 51 per cent discount, according to Raymond James.
A technology fund managed by Blue Owl, which earlier this year permanently halted redemptions on one of its funds, has also been trading at a cut price.
“We’re playing defence,” said Tim Musial, head of fixed income at CIBC Private Wealth, which has been trimming BDC exposure. “You’re just not getting paid enough to stick your neck out right now.”
Additional reporting by Michelle Chan