A primary obstacle to managing a private credit ETF is the inherent mismatch between the vehicle and its underlying assets.NicoElNino/iStockPhoto / Getty Images
Asset managers are looking to bring two of the fastest-growing investment areas – exchange-traded funds and private credit – under one roof with ETFs that track the US$1.7-trillion market for private loans.
Last month, State Street Corp., in partnership with Apollo Global Management Inc., filed an application with the U.S. Securities and Exchange Commission (SEC) seeking approval for a first-of-its-kind ETF that intends to hold private debt directly. Other asset managers have followed suit.
If approved in the U.S., experts say Canadian asset managers will seek regulatory approvals here. And while private credit is the first through the door, it will likely be followed by other private market asset classes including private equity and real assets.
“This is something that hasn’t been done at scale before – there might be a fund here and there with a minute portion of the portfolio in privates, but not this significant,” says Andres Rincon, managing director and head of ETF sales and strategy at TD Securities.
State Street would administer the proposed ETF – SPDR SSGA Apollo IG Public & Private Credit ETF – while Apollo would provide the liquidity backstop, which “brings a slew of tests and complications that need to be solved,” Mr. Rincon says.
A primary obstacle to managing such a fund is the inherent mismatch between the vehicle and its underlying assets. ETFs are traded throughout the day on stock exchanges. As private investments don’t trade publicly, there are questions about the mechanics of how such a fund would operate – in particular during major market volatility.
“It is the issue everybody is trying to figure out,” Mr. Rincon says. “This is not a new endeavour. ETF issuers have been trying to open up the private asset world for quite some time. But it’s not that simple – we are talking about illiquid assets within a liquid wrapper.”
The fund will be invested primarily in public credit in the form of investment-grade loans. Just 15 per cent of the fund will be in private debt, the maximum allowed by SEC regulations.
“This is the cap right now, but it’s how the market is going to test the waters,” Mr. Rincon says.
In the firms’ filings, New York-based Apollo has pledged to “provide intraday, executable firm bids” on the fund holdings, should there be a need to sell positions, allowing those assets in principle to be deemed liquid.
“One thing to keep in mind: just because they said they will provide a firm bid doesn’t mean they will provide a ‘good’ one. They’re going to say, ‘Okay, if you want to sell the asset, you can sell.’ But at what price?” Mr. Rincon says.
“We would expect that it will be subject to price volatility in the same way normal credit would.”
He says it’s not clear how Apollo will manage capital requirements effectively in more volatile markets. The alternative investment giant holds about US$510-billion in assets.
“Clearly, Apollo is a very big company and, depending on the size of this fund, they might have enough liquidity to service those redemptions,” he says.
With the global private credit market expected to more than double to US$3.5-trillion by 2028, according to BlackRock Inc., large U.S. private market operators including Apollo are pursuing efforts to build out trading desks to facilitate market-making and faster price discovery – moves aimed at bringing greater liquidity and transparency to private markets, experts say.
“The moral of the story is, as asset classes grow, typically liquidity follows. And as that liquidity follows, you generally get these more investor-friendly structures such as ETFs,” says Julian Klymochko, chief executive officer of Calgary-based Accelerate Financial Technologies Inc.
Mr. Klymochko’s firm oversees about $130-million in assets for clients, including $30-million in its new Accelerate Diversified Credit Income Fund. Launched earlier this year and traded on the Toronto Stock Exchange, it purports to be Canada’s first private credit ETF.
The fund’s underlying holdings are in U.S. exchange-listed “business development companies,” or BDCs – specialized corporate entities with limited tax obligations, a structure created in the early 1980s to fund smaller private U.S. companies more easily. Today, BDCs are another fast-growing branch of private markets opening up new channels for investors.
The U.S. BDC market has grown to more than US$315-billion, according to data provider LSEG, with many BDC funds going public in the past few years, allowing fund managers such as Accelerate to create fund-of-fund type exposures.
Major private credit managers such as Ares Management Corp., Blackstone Inc. and Carlyle Group Inc. offer both unlisted BDCs as well as publicly traded funds, and Morgan Stanley and Co. LLC introduced a BDC fund earlier this year.
“What we’re investing in, with our private credit income fund, is publicly traded private credit vehicles that trade in the U.S. and are managed by leading private credit managers,” Mr. Klymochko says.
The Accelerate fund holds exposures to about 21 vehicles invested in U.S. BDCs, with about 200 private loans in the average BDC portfolio, he says, giving the fund an aggregate exposure to about 4,200 loans, most of which are senior secured debt and floating rate.
The appeal of such debt is higher yields. A 2023 study from Morgan Stanley analyzed credit returns over various rate cycles in the past 15 years, stating annual yields from direct lending were approximately 11 per cent, compared with 6.8 per cent for high-yield bonds and 5 per cent for leveraged loans.
“There also tends to be higher risk in private credit, which is reflected in the yield,” Mr. Rincon notes.
From an advisor perspective, an ETF structure as a way into private assets has appeal, says Zach Davidson, advisor and portfolio manager with the Fairway Wealth Management team at National Bank Financial Wealth Management in Toronto.
“We haven’t allocated much to the space yet, but we’re watching it closely. We think there are some interesting vehicles that are going to make it easier for investors to access these assets. It’s a matter of balance, ensuring that the products are going to deliver what they’re expected to deliver.”
However, Mr. Davidson’s preference is to rely on funds that invest in publicly listed stocks that hold private equity, credit and real assets, such as NBI Global Private Equity ETF NGPE-T.
The fund tracks Morningstar PitchBook Developed Markets Listed Private Equity Select Index, replicating that basket through investments in many of the world’s biggest allocators to private assets, including Blackstone, KKR & Co. Inc., Partners Group Holding AG and Carlyle Group.
Mr. Davidson says the fund solves for the low correlation and higher performance potential these new direct private asset ETFs are trying to replicate.
“NBI is screening and conducting due diligence in putting together the portfolio. It’s got a track record through a couple of different cycles, while already offering exposure to the space,” he says.