(Bloomberg) — On paper, it seems like a no-brainer trade: Cash out of one private credit fund at 100% of net asset value and plow the money back into a similar vehicle that’s trading at a substantially discounted price.
Like many things in the $1.8 trillion direct lending market, that kind of arbitrage can be trickier and more time-consuming to pull off than it first appears, especially for retail investors. Still, as an avalanche of redemption requests from private credit funds stretches into another quarter, some advisers are urging their clients to make the move.
The strategy hinges on the structural differences between non-traded business development companies, and BDCs that trade like stocks on exchanges. Non-listed BDCs can limit withdrawals but when investors do get cash out, they get their money back at the full net asset value of the fund.
In contrast, listed BDC prices move largely in real time, and right now they’re trading at a median discount to NAV of about 25%, arguably in anticipation of the type of pressure and markdowns that are starting to hit their semi-liquid peers.
“When the same credit manager is running a non-traded BDC at its net asset value and a listed sibling fund at a 24% to 27% discount, that’s not a philosophical debate, that’s a math problem,” John Cole Scott, president and chief investment officer at Virginia-based CEF Advisors, said in an interview.
Discounted
Investors who are patient enough to sell the non-traded vehicle and rotate into a listed one “are effectively buying the same portfolio at a meaningful discount,” he said.
The argument is gaining support as investors ramp up requests to exit the private funds in the second quarter, even after the BDCs handed back more money than they raised in the prior period.
Read more: Ares Private Credit Fund Caps Redemptions After 14% Seek to Exit
Ares Management Corp. on Thursday became the latest asset manager to see a rise in demand for withdrawals, with investors asking for 14.4% of their cash back, up from 11.6% in the first quarter. The $22.6 billion Ares Strategic Income Fund is limiting withdrawals at 5%.
Ares’ publicly-traded BDC, the biggest of its kind, is trading at about an 8% discount to its net asset value of $19.59 as of March 31.
With billions trapped in private vehicles, wealth advisers say that recommending a more liquid version of the funds has become prudent. “If you want BDC exposure, take it in the publicly traded vehicles,” said Josh Barone of Savvy Advisors. “You get daily price discovery, transparent leverage, real redemption mechanics, and the market is already telling you what these books are actually worth.”
At about 83%, the price to book ratio for publicly traded BDCs is below its longer-term average of 95%, according to data compiled by Bloomberg. An index of BDCs is down 11% so far this year, compared with a 1.38% gain in the US leveraged loan market over the same period, the data show.
The advice still holds merit for some investors being blocked from withdrawing their cash by asset managers including Apollo Global Management Inc., Blackstone Inc. and BlackRock Inc., which all enforced limits on redemptions from their funds.
In practice, it’s not as simple.
Private and public BDCs from the same manager can invest in different assets, with varying degrees of risk. The private vehicles usually operate with lower leverage levels than publicly-traded BDCs, and hold a greater proportion of liquid credit, including public market loans. Public BDCs tend to charge higher fees.
And while a focus on luring retail clients has helped assets under management at the private funds swell to about $373 billion, the investor base can vary widely between non-listed funds.
Ohio-based adviser Clearstead, for example, has exposure to some private BDCs that are more institutional than retail, according to Chief Investment Officer Aneet Deshpande. He has no plans to ask his clients to move their capital out of such funds, he said.
“Going from one of our institutional private credit managers that has a BDC vehicle to a public BDC is an apples and oranges comparison in terms of underwritten outcomes,” Deshpande said. “I would not do that.”