As private credit investment products designed for the wealth channel experience growing pains, financial advisors are taking a measured approach to the asset class, with some continuing to see opportunities amid the tumult while others rethink whether retail investors are suited for fundamentally illiquid investments.
That was the tenor of conversations throughout the three days of last week’s Wealth Management EDGE conference held at The Boca Raton resort in Boca Raton, Fla.
The discussions came amid a backdrop of a handful of non-traded business development companies and interval funds focused on private credit reaching a slew of redemption requests from increasingly skittish investors.
The products are designed with caps, limiting redemptions per month and quarter (typically 1% and 5% of a fund’s AUM, respectively). A few funds have received requests to redeem well above those thresholds. As a result, redemptions are pro-rated, with investors receiving a portion now with the rest coming in future months and quarters.
The run on the funds has been precipitated primarily by concerns about loans to software firms, which are facing headwinds and potential disruptions by the rapid advance of artificial intelligence, as native AI functionality may replace some standalone software.
Backers arguing the bull case have pointed out that the concerns emanate from just one corner of the private credit market, whereas other swathes (such as asset-backed finance, real asset loans and loans to other corporations), maintain healthy fundamentals. Therefore, many private credit funds are not exposed at all.
On the flip side, other advisors are worried about contagion and that some retail investors overall are not suited for illiquid investments.
Preaching Caution
Participants in “The Future of Income Strategies” fireside chat at Wealth Management EDGE were not big fans of private credit products for retail investors.
Private credit is not an inherently bad investment option, said Erik Lehr, CIO at Empirial Wealth Management. Lehr does not believe the private credit sector as a whole is facing a crisis—some defaults are an expected part of the private credit business, and right now they are nowhere near historic highs, he said. However, he said asset managers running evergeen private credit funds did not have a good grasp on retail investor behavior when they were designing these products.
“Anyone of us who has ever sat with a retail client could have told them exactly what was going to happen,” he said. “As soon as things get scary, everybody wants to head for the door, and they don’t understand why they can’t do it. So, private [credit managers] right now are in a struggle of their own making.”
For Sam Huszczo, founder and CIO at SGH Wealth Management, private credit simply does not offer clients any benefit that they couldn’t access by investing in more stocks. And the fact that private credit funds tend to provide NAV estimates on a quarterly basis, often with limited transparency into how those NAVs are calculated, can obscure the losses these funds incur when the market goes down.
“To me, this is like going to a restaurant that doesn’t have any prices on the menu. Everybody is having a blast until the bill comes,” Huszczo said.
Since private credit is not going to offer downside protection in a downturn, what is the purpose of having it in a client’s portfolio, he asked. And even if clients insist they need private credit allocations because they’ve heard all the buzz, if the advisor does not believe they will add value, the right thing to do is to steer the client away from those.
“A portfolio should not just be a collection of investments—what you love and what speaks to you in that moment,” Huszczo said. “It should be a collection of solutions for future problems.”
Still Some Believers
At the other end of the spectrum, advisors and asset managers at the conference noted that first-lien yields have normalized to 9% and that inflows into private credit BDCs and ETFs remain strong.
Patrick McGowan, managing director, head of manager research and head of alternative investments at Sanctuary Wealth, categorized the approach as “rotation, risk, reset and re-entry,” pointing out that private credit accounted for 32% of fundraising in April from the wealth channel as investors have rotated to private equity, real estate and real assets. (A year ago, private credit accounted for 56% of flows from the wealth channel to alternative assets.)
According to McGowan, a question advisors should ask themselves: “Is your book positioned for where the market was or where it is going?”
On the risk front, pressures are largely contained to one corner of the private credit market. As the market resets, McGowan sees a potential re-entry point next year. The pressures created by disruption to software firms will eventually work their way through balance sheets, which could create a natural re-entry point next year as spreads widen, terms improve and software loans are refinanced.
Some argued that publicly traded BDCs represent an opportunity, as share prices have dropped amid broader market concerns, potentially putting them at a discount to underlying net asset value. That was a point underscored by both Stephen Tuckwood, director of investments, Modern Wealth Management, and Matt Dmytryszyn, chief investment officer, Composition Wealth, during a session on the fixed income landscape.
Tuckwood and Dmytryszyn said they are assessing the potential of investing in publicly traded BDCs since they are trading at 10% to 20% discounts relative to NAVs, if those valuations are accurate.
“They have gotten beaten up,” Tuckwood said. “Maybe some of that is overdone.”
Dmytryszyn said the opportunity could be “good but not great,” based on public BDC loan books generally having lower quality assets than non-traded BDCs. He added that another aspect to watch is that, even with some issues, private credit yields may still be attractive enough overall to stay allocated, with the challenge being to assess whether losing 200 to 300 basis points over a few years in private credit still leaves investors above traditional fixed-income allocations.