Private credit managers are feeling sheepish. Some of their investors can’t get their money out as quickly as they’d like — and some may be quite angry about that. Cue the tentative non-apologies for any misunderstandings people had about getting their cash back. “Between us, and the advisers who sell our products, I don’t think we made it clear enough,” Doug Ostrover, co-chief executive officer at Blue Owl Capital Inc., told a conference in Australia on Thursday.
Upsetting customers is generally bad news. For private credit firms it will likely hurt their ability to raise fresh funds in future, but more importantly it’s when voters feel burned that politicians smell opportunity. And that rarely bodes well for finance. The best thing that could come from this troublesome spell is that the US rethinks its plan to allow many more private assets into ordinary folks’ retirement funds.
Private credit funds usually lend money directly to private equity-owned companies, typically for five years. But these kinds of illiquid investments are only suitable for normal folk in very small doses and with strict guardrails. Too much retail money would be a big accident waiting to happen that would ultimately harm both fund managers and financial stability.
The past few weeks has seen one firm after another frustrate requests from individual investors to get their money back. These clients are worried about recent fund losses and other potential problems such as heavy lending to AI-threatened software companies. But firms are mostly sticking to the letter of quarterly redemption limits in the face of much larger demands.
The unlisted business development companies, as these special funds are known, are an important subsection of the $1.8 trillion private-lending market. And they are doing the right thing by husbanding their free cash and not rushing to offload hard-to-sell loans to raise money to return to investors.
Just this week, a fund run by Ares Management Corp. capped withdrawals at 5% of net assets when redemption requests amounted to 11.6% of shares in the vehicle. Apollo Global Management Inc. also stuck to the same standard quarterly limit after investors asked for 11.2% of their money back. Funds run by Blackrock Inc., Blackstone Inc., Cliffwater LLC and Morgan Stanley have seen high demand for redemptions, too. Many vehicles also reported quarterly losses because of the declining value of loans they hold after years of strong returns.
Limiting payouts is the right move because it halts the viral contagion of falling loan prices, more market value losses and further panicky withdrawals. Unchecked, that could turn a credit drama into a crisis. Retail investors are not happy, though. The exit queues could be even longer next quarter.
Managers insist that credits in their funds remain good even if higher borrowing costs are depressing loan values. Institutional investors are said to still be investing fresh cash even as some individuals turn tail. Still, there are plenty of worries about potential losses, especially on loans to software companies. The most bearish expectations are for 15% of private credit borrowers to default, and for recoveries as low as 20% of loan values. That would mean losses of 12% of an average portfolio, or double that if a fund is leveraged with an equal amount of borrowed money.
It’s clear why investors might want to jump ship, but they should have known it wouldn’t be easy. BDC funds aren’t nearly as simple as the managers and marketing people might want clients to think, but one thing clear from a cursory look at their documents is that there was never any guarantee of getting your money back when you want.
In every prospectus I’ve looked at, the second or third bullet point at the front says in bold: “You should not expect to be able to sell your shares regardless of how we perform.” Did investors bother looking? Did their financial advisers highlight this point? The comments from Blue Owl’s Ostrover suggest firms are starting to worry about the answers to these questions.
At the same conference, Jim Zelter, Apollo’s president, mused that certain distribution channels in certain parts of the world might have sold the funds without ensuring investors fully grasped this risk. I’ve had plenty of emails over recent weeks that presume wealth managers and financial advisors should be blamed rather than the private credit firms.
The distinction might not help if the pressure to redeem keeps growing and the disquiet becomes political. Lloyd Blankfein, former boss of Goldman Sachs Group Inc., talked about the risks of Wall Street getting involved with mom-and-pop clients on the Bloomberg Big Take podcast at the start of March. Governments don’t care that much when big institutions suffer losses in any particular product because they can afford it, he said. “But when you lose money for individuals, for consumers (ie taxpayers and citizens) people in government get very, very upset. Regulators get very, very upset.”
We have seen this movie many times with complex, illiquid or structured investment products sold to individuals, even wealthy ones. It often ends badly for the firms involved. Private-asset managers, politicians and regulators should keep this in mind as the industry pushes hard to get more of their funds into the hands of ever more households. Mostly, they should just not do it.
A message from Advisor Perspectives and VettaFi: Discover something new! Click here to register for our upcoming webcasts.
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
Read more articles by Paul J. Davies
