Public credit funds like BDCs, JFR, and VVR sell retail investors a version of private credit that breaks under stress. They invest in similar senior secured loans, typically with 30 to 40% leverage to boost returns.
But there's an issue of the public nature. The funds hold illiquid, floating-rate loans. And those don't trade frequently. However, their shares are trading daily.
When there's an problem in the credit markets, their investors get hammered twice.
First from the drop in the loan values. And then from panic selling as retail holders dump shares and freak out. This selling pressure drives prices well below NAV (evident on the charts on CEFConnect and other sites). It's not because the loans defaulted .... it's because of liquidity gaps and forced exits.
Private credit funds aren't exposed to this problem. Companies like Apollo and Ares use multi-year lockups and limited redemptions. These private pools don't mark to market and there isn't any forced selling.
Retail investors believe that they are accessing private credit. But I would argue they're just absorbing all of the market's credit risks... and there's not lock-in protection.
Those public vehicles are canaries in the coal mine (so is AIG stock).
These are the things that break first. It takes a while for the private funds to catch up.
Well, that’s sobering! Clearly, though, there are bright spots for retail investors in the private credit space. You mentioned you took advantage of the April crash to buy more shares of FSCO. And your father-in-law thinks highly of ARCC. Anything else in private credit you think might not be poison for retail investors?
Bad for the system, but is it not good for big banks (at least short term)? The banks have better balance sheets and are making the money without taking the risk. Am I missing something?
When private credit blows up, banks lose their biggest fee generators overnight while having spent years NOT building real lending relationships. They're trading long-term franchise value for short-term fees (you're right about the short-term)...
JPMorgan used to BE the credit market. Now they're just middlemen while Apollo owns the relationships. Plus, banks are still on the hook for "warehouse" lines to these funds.
They haven't eliminated risk. They just obscured it.
Where do publicly traded BDCs, and publicly traded funds like JFR and VVR that invest in pre-existing private credit, fit into this?
Great question.
Public credit funds like BDCs, JFR, and VVR sell retail investors a version of private credit that breaks under stress. They invest in similar senior secured loans, typically with 30 to 40% leverage to boost returns.
But there's an issue of the public nature. The funds hold illiquid, floating-rate loans. And those don't trade frequently. However, their shares are trading daily.
When there's an problem in the credit markets, their investors get hammered twice.
First from the drop in the loan values. And then from panic selling as retail holders dump shares and freak out. This selling pressure drives prices well below NAV (evident on the charts on CEFConnect and other sites). It's not because the loans defaulted .... it's because of liquidity gaps and forced exits.
Private credit funds aren't exposed to this problem. Companies like Apollo and Ares use multi-year lockups and limited redemptions. These private pools don't mark to market and there isn't any forced selling.
Retail investors believe that they are accessing private credit. But I would argue they're just absorbing all of the market's credit risks... and there's not lock-in protection.
Those public vehicles are canaries in the coal mine (so is AIG stock).
These are the things that break first. It takes a while for the private funds to catch up.
Thank you for the thoughtful reply, Garrett.
Well, that’s sobering! Clearly, though, there are bright spots for retail investors in the private credit space. You mentioned you took advantage of the April crash to buy more shares of FSCO. And your father-in-law thinks highly of ARCC. Anything else in private credit you think might not be poison for retail investors?
Bad for the system, but is it not good for big banks (at least short term)? The banks have better balance sheets and are making the money without taking the risk. Am I missing something?
Technically. But the fee game has a shelf life.
When private credit blows up, banks lose their biggest fee generators overnight while having spent years NOT building real lending relationships. They're trading long-term franchise value for short-term fees (you're right about the short-term)...
JPMorgan used to BE the credit market. Now they're just middlemen while Apollo owns the relationships. Plus, banks are still on the hook for "warehouse" lines to these funds.
They haven't eliminated risk. They just obscured it.
When this unravels, guess who gets blamed?
The banks, not Apollo.