The Rise of Private Credit ETFs

Private credit ETFs have been gaining traction in recent years, and for good reason. They offer investors a unique way to access the private credit market, which has historically been reserved for institutional investors.

Private credit ETFs allow investors to diversify their portfolios by investing in a broad range of private credit assets, such as loans and debt securities. This can be particularly beneficial for investors seeking to reduce their reliance on traditional public markets.

The private credit market has grown significantly in recent years, with assets under management increasing from $1.2 trillion in 2015 to $2.7 trillion in 2020. This growth is expected to continue as more investors seek to tap into the market's potential.

Investors are drawn to private credit ETFs because they offer a relatively low-risk investment option with the potential for attractive returns.

The BondBloxx Private Credit CLO ETF (PCMM) is subadvised by Macquarie Asset Management.

PCMM invests at least 80% of its assets in private credit collateralized loan obligations (CLOs), providing direct exposure to private credit middle market companies.

These middle market companies are a central driver of U.S. economic growth, representing one-third of U.S. private sector GDP and generating $13 trillion in annual revenue.

The fund offers diversified exposure to private credit opportunities across the entire U.S. middle market, not limiting the universe of private credit opportunities to a single underwriter.

The PCMM ETF is designed to provide investors with opportunities across the entire U.S. middle market, leveraging the expertise of BondBloxx in private markets investing.

Here are some key investment details of the PCMM ETF:

The Virtus Credit ETF is a cost-efficient way to access private credit through investments in business development companies and select closed-end funds.

It's notable that this ETF will invest at least 80% of its net assets in a portfolio of investment-grade debt securities, including both public and private credit investments.

The fund will invest up to 15% of its net assets in private credit, which aligns with the U.S. 1940 Act's allowance for funds to hold 15% of their portfolios in illiquid assets.

The Virtus Credit ETF is still awaiting regulatory approval, but it has the potential to provide a unique investment opportunity for those looking to access private credit markets.

Apollo Global Management has partnered with State Street Global Advisors (SSGA) on a new product, the SPDR SSGA Apollo IG Public & Private Credit ETF, which will also invest in private credit instruments.

This ETF will include direct lending to private companies in private offerings, as well as asset-backed securities such as commercial real estate, residential mortgage loans, and consumer finance instruments.

The Fund aims to provide an alternative source of yield to traditional fixed income by focusing on the private credit market. This involves tracking the Indxx Private Credit Index, which offers passive exposure to listed instruments that emphasize private credit.

Private credit instruments, such as business development companies (BDCs) and closed-end funds (CEFs), are often publicly traded and subject to federal regulations designed to protect investor capital. These regulations help ensure the protection of investor capital.

Private credit typically carries higher yields than traditional corporate high-yield bonds, along with a higher anticipated recovery in the case of default. This makes it an attractive option for investors seeking higher returns.

The private credit market is a fast-growing segment of the U.S. financial markets, representing more than $30 trillion. However, access to this asset class has been limited primarily to large institutional and high net worth investors.

Here are some potential benefits of investing in private credit:

ETF solutions for asset management are evolving to include private assets, offering investors a new way to diversify their portfolios. Private assets, such as private credit, private equity, and real estate, have been growing rapidly in recent years, with AUMs tripling to over $13 trillion in 2023.

The democratization of private assets through ETFs is a significant development, as it provides investors with easier access to these previously illiquid markets. This is expected to create a more accessible and transparent marketplace with several potential benefits.

The first private credit ETF, the BondBloxx Private Credit CLO ETF (PCMM), has already been launched, offering investors direct exposure to middle market companies. This ETF invests at least 80% of its assets in private credit collateralized loan obligations (CLOs) and provides a diversified portfolio of private credit opportunities.

Investors can use private asset ETFs in various ways, such as:

• As a strategic allocation in portfolios to seek enhanced returns and increased diversification

• As a complement to broader credit in fixed income allocations, to include both public and private corporate bonds

• As the liquid portion of private credit and alternatives allocations

The benefits of private asset ETFs include diversification, enhanced returns, and less exposure to short-term volatility. However, there are also potential challenges to consider, such as NAV dislocations and arbitrage of illiquid assets.

The SPDR SSGA Apollo IG Public & Private Credit ETF is a collaboration between SSGA and Apollo Global Management, with Apollo sourcing all debt instruments held in the fund.

At least 80% of these debt instruments must be investment grade, which is a crucial aspect of the fund's structure.

Private credit instruments will also be held in the fund, including direct lending to private companies in private offerings and asset-backed securities such as commercial real estate and residential mortgage loans.

Apollo will provide executable quotations on all private credit instruments and purchase them from the fund at or above the quoted price, up to a daily limit that is undefined.

This contractual agreement between Apollo and the fund may allow it to circumvent the SEC rule prohibiting open-ended vehicles like ETFs from holding more than 15% of their assets in illiquid investments.

The holdings of the proposed ETF are available for download.

The Virtus Private Credit Strategy ETF has disclosed its holdings for fiscal Q1 and Q3.

You can access the holdings for each quarter by downloading the relevant documents.

A small portion of the portfolio will be invested in private assets.

Here is a summary of the available holdings documents:

The SPDR SSGA Apollo IG Public & Private Credit ETF is a result of a partnership between SSGA and Apollo Global Management. This ETF will invest at least 80% of its net assets in a portfolio of investment-grade debt securities.

Apollo will source all the debt instruments held in the fund, including public credit-related investments and private credit investments. The fund will invest up to 15% of its net assets in private credit, which aligns with the U.S. 1940 Act's allowance for funds to hold 15% of their portfolios in illiquid assets.

Some of the holdings will be private credit instruments, including direct lending to private companies in private offerings. Asset-backed securities like commercial real estate, residential mortgage loans, and consumer finance instruments will also be included.

Apollo's contractual obligations as liquidity provider may allow it to circumvent the 15% limit on illiquid investments, as per SEC rules. The agreement requires Apollo to provide 'executable quotations' on all private credit instruments and purchase them from the fund, up to a 'daily limit', at or above the quoted price.

The liquidity of private assets is a major concern when it comes to private asset ETFs. This is because private assets often lack intraday liquidity, making it challenging to trade and price them.

ETFs, on the other hand, are known for their liquidity, allowing easy buying and selling. However, the liquidity mismatch between the underlying assets and the ETF vehicle can make intraday trading and pricing difficult.

In times of market distress, even if the ETF has a liquidity provider, the valuation of the underlying asset will come under pressure as supply increases, leading to pricing variability. This could result in higher create/redeem fees for ETF buyers and sellers.

According to Example 5, "the liquidity of an asset plays on its transactable prices." This means that the liquidity of an asset affects its price, making it harder to buy and sell in times of distress.

ETFs that invest in private assets may face similar illiquidity discounts in times of distress, as seen in the experience of many bond ETFs during the pandemic.

Here are some key statistics on the liquidity of private assets:

ETFs that invest in private assets may face higher create/redeem fees and illiquidity discounts in times of distress.

Private credit ETFs offer a range of benefits and features that can be attractive to investors.

They provide diversified exposure to business development companies and closed-end funds focused on private credit markets.

Targeted exposure can help reduce sensitivity to interest rates, making them a powerful diversifier in a portfolio.

High yield potential is another benefit, with regularly scheduled quarterly distributions offering an attractive income opportunity.

Private credit ETFs can also provide access to a broad range of private assets, reducing the risks associated with a single issuer.

This diversification can allow investors to benefit from the overall growth of the private asset industry.

The BondBloxx Private Credit CLO ETF (PCMM) offers direct exposure to private credit middle market companies, which have previously been available primarily to large institutional and high net worth investors.

The ETF invests at least 80% of its assets in private credit collateralized loan obligations (CLOs), providing a diversified portfolio of small- and middle-market lenders.

This allows investors to own private credit CLOs from any of the major underwriters, providing opportunities across the entire U.S. middle market.

Here are some potential use cases for the exposure offered by private credit ETFs:

Private credit ETFs, like any investment product, come with their own set of challenges and considerations. Despite their promising potential, these products may face several hurdles.

One of the main challenges is the limited access to private credit, which has been primarily available to large institutional and high net worth investors. This is due to the fact that private credit is a fast-growing segment of the U.S. financial markets, representing more than $30 trillion.

Investors should consider the diversification benefits of private credit exposure, which can provide a key aspect of portfolio diversification. PCMM, the first ETF to offer direct exposure to private credit, invests at least 80% of its assets in private credit collateralized loan obligations (CLOs).

The diversified nature of the fund's holdings themselves is also a significant advantage, allowing investors to own private credit CLOs from any of the major underwriters. This can provide opportunities across the entire U.S. middle market, making it an efficient way to participate in private credit with the liquidity, transparency, and cost advantages of an ETF.

Private asset ETFs face several hurdles, including the liquidity mismatch between the underlying assets and the ETF vehicle. This can make intraday trading and pricing challenging.

The liquidity of an asset plays a crucial role in its transactable prices, and in times of market distress, the valuation of an asset can come under pressure as supply increases, leading to pricing variability.

Private asset ETFs could face similar illiquidity discounts in times of distress, just like many bond ETFs that experienced discounts to their Net Asset Value (NAV) and ballooning create/redeem fees during the pandemic.

ETFs are known for their liquidity, but private assets often lack intraday liquidity, making it difficult to price these assets accurately.

Higher create/redeem fees for ETF buyers and sellers could result from the challenges of pricing these assets, making it essential to understand the liquidity risks involved.

Issuers may face significant regulatory hurdles in launching a private credit ETF in Europe. The European Securities and Markets Authority (ESMA) has strict guidelines for UCITS (Undertakings for Collective Investment in Transferable Securities) that may limit the types of private credit securities that can be included in an ETF.

In fact, if a private credit security is issued by an unlisted corporation, a UCITS may not invest more than 10% of its assets in such loans. This restriction could make it difficult for issuers to create a diversified private credit ETF.

Issuers may also be hesitant to launch a private credit ETF due to the relatively low demand in Europe compared to the US. The ETF market participation and infrastructure development rates in Europe are far below those of the US, making it a less attractive proposition for issuers.

The cost of compliance with regulatory requirements and the potential for low returns may outweigh the benefits of launching a private credit ETF in Europe.

In Europe, the regulatory environment for private credit ETFs is likely to be challenging. European regulators are unlikely to be acquiescent due to concerns about the liquidity and transferability of loans.

The UCITS definition of an MMI includes instruments with regular yield adjustments, which could potentially make it possible to invest in floating rate unsecuritised loans. However, these loans must also be liquid, freely transferable, and capable of being accurately valued, which they appear to be at odds with.

The Luxembourg regulator, the CSSF, has previously announced that it does not consider loans to be eligible assets.

Regulatory Approval is a crucial step in the process of launching a new product, especially one that involves private assets. The new filing is still pending regulatory approval.

Regulators like the SEC are closely monitoring the development of private asset ETFs, and one key concern is the liquidity risk associated with them. This risk can be mitigated if the private equity company provides intra-day, executable firm bids on illiquid assets.

Regulators are likely to view the proposal with skepticism, particularly in Europe where the definition of transferable securities is strict.

Sergey Dolomanov, a partner at William Fry, believes that loans will not qualify under the UCITS definition of transferable securities, mainly because they are not shares, bonds, or units in other funds.

The UCITS definition of an MMI, however, includes instruments with regular yield adjustments, which could potentially make it possible to invest in floating rate unsecuritised loans.

But for an instrument to be considered an MMI, it must be liquid, freely transferable, and capable of being accurately valued, which loans appear to be at odds with.

European regulators are unlikely to be acquiescent, as the Luxembourg regulator, the CSSF, has previously announced that it does not consider loans to be eligible assets.

Jose Garcia-Zarate, associate director of manager research at Morningstar, has serious doubts that an arrangement similar to SSGA and Apollo's would be acceptable in Europe, citing concerns about the arrangement's potential to generate red flags for regulators and investors.

Private credit ETFs aim to deliver an alternative source of yield to traditional fixed income by focusing on the private credit market.

The Fund seeks to track the Indxx Private Credit Index, which provides passive exposure to listed instruments that emphasize private credit. This includes business development companies (BDCs) and closed-end funds (CEFs).

Private market assets include private equity, venture capital, private credit, real estate, and infrastructure – investments in privately owned, rather than publicly traded, assets.

Private asset ETFs offer a unique way to invest in private credit, providing benefits like diversification and professional management. This is a game-changer for investors who want to access private markets.

Private asset ETFs can also introduce more price transparency and secondary liquidity than traditional private assets. This is a big plus for investors who want to easily buy and sell their investments.

The ETF industry is working to address challenges, including the liquidity mismatch between the ETF structure and its illiquid holdings. This is a complex issue, but it's great to see the industry taking steps to address it.

Here are some benefits of private asset ETFs:

The democratization of assets is a game-changer for investors. Private assets, which include private equity, venture capital, private credit, real estate, and infrastructure, are becoming more accessible to a wider range of investors.

Private assets have seen rapid growth over the last decade, with assets under management (AUM) more than tripling to ~US$13 trillion in 2023. This upward trajectory is set to continue, with analysts predicting AUM to surpass $18.3 trillion by 2027.

ETFs are playing a key role in democratizing access to private assets, allowing investors to gain exposure to these previously hard-to-access markets. In fact, fixed income ETFs already represent nearly 30% of ETF AUM in Canada and continue to grow rapidly.

The ETF structure is well-suited for bonds, and now it's being explored for private assets. This could bring a new level of transparency and accessibility to the private market, making it easier for investors to participate.

Private asset ETFs will give investors easier access to private assets, potentially creating a more accessible and transparent marketplace.

Investing in private credit ETFs can provide a unique opportunity for investors to gain access to a traditionally closed market. Private credit investments have historically provided higher yields than traditional corporate high yield bonds, along with a higher anticipated recovery in the case of default.

One of the key benefits of private credit is its relatively low volatility compared to high yield investments in public debt markets. This makes it an attractive option for investors looking to diversify their portfolios.

Private credit investments are often made in publicly traded companies, such as business development companies (BDCs) and closed-end funds (CEFs), which are subject to federal regulations designed to protect investor capital. This added layer of oversight can provide an extra level of security for investors.

By investing in private credit, you can potentially increase your income through significantly higher yields, while also achieving attractive risk-adjusted returns. This can be a valuable addition to a diversified investment portfolio.

Here are some key benefits of investing in private credit ETFs: