Nearly two years ago, I wrote a post titled “Now is not the time for investing in private credit”. Read it here.
It caused a fair bit of LinkedIn pearl clutching, some condemnation, and more than a few people telling me I was wrong.
My core view was simple. That in this sector, there were key risks that investors either did not fully understand or were not being adequately compensated to take. Caution was warranted.
Fast forward to today. A lot has been happening.
This morning, I woke to the news that Blue Owl, a large US-based global private credit group with a very good reputation, has halted redemptions at OBDC II, a private credit fund marketed to retail investors with promised quarterly liquidity. They have shut the “gate”. (see the FT article here)
When managers start limiting exits, the industry term is “gating”. It is often because the underlying assets cannot be realised at the prices investors think they are worth. It’s often the right thing to do. Just difficult when an investor doesn’t understand it or has not planned for it through proper portfolio construction. Investors always forget that in distress, liquidity evaporates.
On the home front, late last year, ASIC released its Private Credit Surveillance Report 820, reviewing 28 retail and wholesale funds. I never thought I would say this about any ASIC report, but it was a really interesting read! (check it out here)
Sadly, ASIC found that on some of the most fundamental concepts, disclosure, fee transparency and valuations, the industry really missed.
Some of the most important findings were:
Funds defined “default” differently. Without a consistent definition, how can investors meaningfully compare risk? A loan can be distressed long before it is labelled “in default”, depending on the definition used. It also explains why so many private credit funds have told me they have never had a default! Definition is everything.
Less than half of the funds had detailed, written credit or impairment and default management policies in place. I would have thought handling a default is a pretty fundamental part of running a private credit fund. I would have thought writing the process down was even more fundamental.
Of the wholesale funds, only two performed stress testing as part of their liquidity risk management. Stress testing is about modelling different scenarios to see how a fund would perform under pressure. Wholesale funds are exclusive to high-net-worth and sophisticated investors. I work exclusively in this space. Wholesale really can be the wild, wild west of investing sometimes. Although the investors are sophisticated, they hire me to do the due diligence to ensure they don’t get caught out by some of the complexities in these products.
ASIC noted that no fund disclosed statistics on loans using payment in kind, even where it appeared to be offered. When interest is rolled into the loan rather than paid in cash, distributions can look smooth while underlying stress builds. The outcome is rarely good.
Many funds retained borrower fees and net interest margins without clear disclosure. That means investors can fundamentally misunderstand what they are paying and where the manager’s incentives truly lie.
Most funds did not effectively separate the investment committee approving loans from those overseeing valuations. These assets are not traded daily. Valuations are model-driven. That can smooth returns, but it can also hide problems. Having the same people originate and value the loans is risky.
I still hold the same view I did two years ago.
Private credit can be done well. There are good managers out there, but I still caution is warranted.
As always, I am prepared to be attacked for this view. But I would rather be early and unpopular than late and surprised.
Kind regards,
Shelley Marsh
Outsourced Chief Investment Officer (OCIO) & Founder
Wealth Differently
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