Good morning and happy Sunday.
Welcome to the debut edition of our weekend Deep Dive where we take extended looks at the important topics shaping the world of wealth management. We hope you’re as excited for an extra Advisor Upside each week as we are, because let’s face it, there’s just no such thing as too much wealth management tea.
This week, we’re exploring new private credit opportunities for clients, like exchange-traded funds, that are quickly becoming the next shiny object.
But before we dive in, here’s a quick word from our presenting sponsor, White Wolf Capital.
Private assets have been, for decades, one of the strongest growth drivers on Wall Street. A few key factors have come together to make that a reality:
- Post financial-crisis regulation, crimping the role of bulge bracket banks in the commercial lending arena.
- A wave of capital from sovereign wealth funds, pension funds, and, increasingly, retail investors into the channel.
- A dearth of IPOs, keeping more enterprises private for longer.
White Wolf Capital’s WHITEWOLF Publicly Listed Private Equity ETF offers exposure to this trend with the efficiency of the ETF wrapper, and none of the illiquidity, complexity or long term commitments involved with becoming an LP at a private capital fund.
Do you have clients inquiring about investing private equity or private credit?
Advisors Want In on Private Credit. Should They?
Private credit is hot.
The high-yielding asset class, which was spurred by the global financial crisis of 2008, now boasts $2 trillion in assets. That’s been driven mostly by institutional investors, but increasingly very wealthy two-legged ones as well. McKinsey & Company expects some $6 trillion in assets to pour into private credit over the next decade as new strategies are adopted by asset managers. But is it getting too hot for clients?
“It’s way too crowded now,” said Jon Foster, CEO of the $1.8 billion AUM advisory firm Angeles Wealth Management in Santa Monica, California. “You still have fantastic fund managers who do this, but what happens is there starts to be a push to get money placed, and then you start to have weaker underwriting.”
It’s a Private Party
The next frontier for fund managers may be the mass market. BondBloxx and Virtus Investment Partners launched the first private-credit exchange-traded funds in December. For financial advisors, private credit offers attractive yields for clients and an ability to diversify income strategies. Yields in the low double-digits are the norm, and investors can make monthly purchases and quarterly redemptions. There’s also a base fee of around 1.25% in addition to a low-double-digit performance fee.
“This is another tool in the toolbelt so it’s not just the 10-year Treasury, say, or dividend-growing stocks,” said Craig Robson, managing director at Regent Peak in Atlanta. Not all advisors say they are seeing signs of credit deterioration just yet. “Will we have a scenario where underwriters get a little lackadaisical in their diligence?” Robson said. “I hope that won’t be the case — but hope isn’t a strategy, as we all know.”
Pick a Partner. As private clients clamor for exposure, some advisors worry that clients don’t really understand what they own or the risks involved. Monish Verma, CEO of Vardhan Wealth Management in Farmington Hills, Michigan, said there has been a steady proliferation of private-credit managers. Verma’s due-diligence checklist includes a portfolio’s size and the manager’s experience. “I don’t want to see an equity manager being a private credit manager, where six months ago they were running some sort of equity strategy,” he said. “We want to make sure they’ve been in the space for a while.”
That applies to previous managers at the firm and ones getting added around its private-credit offerings, Verma said. “If we’ve been using them for international, I want to know why they feel they can get into private credit now,” he said. “A lot of investment houses are looking at private credit just because they know investors want it — we’re trying to stay away from those kinds of options.”
Pay the Tax Man. Angeles’ Foster said very few private clients should be in private credit. A major hurdle: Private-equity yields are treated as ordinary income, which means his California-based clients would lose half of their yield to state and federal taxes. While his firm actually has an in-house private-credit fund of funds, “there are very few private taxpaying individuals we have put in that because it’s extremely tax inefficient,” he said.
Foster also wonders why the small- and midsize companies borrowing privately don’t just issue stock to raise capital. “My thinking is that if someone needs my money badly enough to pay 12% or 14% plus warrants, maybe I don’t want to do the deal,” he said. And don’t forget that private credit is risky, he adds: If private credit yields a net 6%, and a Treasury bond nets 3% but is twice as safe, why not buy the Treasury? Others, including Robson, noted that private-credit funds typically have front-of-the-line repayment rights in case of default.
Private Property. Still, private credit has been embraced by countless advisors to qualified-investor-level clients, and being in states with low or no income taxes helps with the yield issue. Wall Street firms like Blackstone Group, Apollo Global Management, Ares Management, and Blue Owl Capital package loans to small- and mid-market private companies that have difficulty getting bank loans thanks to tougher regulations after the 2007-2009 crisis.
There are also dozens of applications for private credit ETFs. Some applaud the idea as broadening access to investment opportunities. The new funds from BondBloxx and Virtus are structured to help accommodate retail investors’ need for liquidity. The ETFs can buy and sell more easily than traditional alternative investments because they invest in private credit indirectly, through collateralized loan obligations. And they’re cheaper: Virtus fund charges a fee of just 0.29%, and BondBloxx’s fund charges 0.68%.
Foster thinks the tradeoffs for liquidity, low pricing and the absence of tedious K-1 forms will be lower returns, which he called “betafication.” The hurdles to investing in traditional PC funds are the very reason for their high expected returns, he argues: “Basically this should not be a retail product, but they’re trying to make it one.”