Private credit and mini-millionaires don’t mix

Shuli Ren, Bloomberg

As fundraising from pension and endowment funds slows, private credit managers have set their eyes on wealthy individuals. The success of the $54 billion Blackstone Private Credit Fund, which launched less than four years ago, prompted the likes of Blue Owl Capital Inc. to establish their own versions. And they’re setting lofty growth targets. Ares Management Corp., for instance, is planning to expand its assets under management by almost 75% to $750 billion by 2028, with a good chunk of the money expected from retail.

The pitch to the mini-millionaires is simple — they don’t need to worry about public markets’ extreme fluctuations. But is the $1.7 trillion industry ready for a new clientele that might be more flighty and — gasp — ready to air their grievances in public if a fund’s performance is underwhelming?

To lure private wealth, new funds are allowing people to withdraw money at regular intervals, as opposed to the more traditional closed-ended structures where institutional investors’ capital is locked up for the life of the fund, which can last a decade. Stakeholders in Blackstone Inc.’s private credit fund, for instance, can redeem up to 5% of total net asset value each quarter, per board approval.

Still, there’s a question over whether it’s a good idea to sell illiquid investment strategies to a group of people who are not as patient as, say endowment funds. Blackstone’s real estate trust for wealthy individuals spent a good chunk of 2023 curbing withdrawals and ensuring shareholders that this strategy “worked as intended.” Last week, Starwood Real Estate Income Trust’s decision to scale back redemptions and avoid property fire sales was another reminder that individual investors hate to see their money trapped for a long time.

Granted, private credit funds are in a much better place than real estate trusts, which are beset with higher mortgage costs and a global commercial property downturn. Nonetheless, market narratives can turn overnight, and a soft landing may not pan out. Companies are defaulting at the highest rate since the Global Financial Crisis, according to S&P Global Ratings. This will necessarily test the resilience of private credit funds.

Other dark clouds are on the horizon. After two years of ceding turf to direct lenders, banks, which are the public debt markets’ gatekeepers, are striking back. To win deals, private credit managers are offering cheaper loans, thus hurting their portfolio returns.

There’s also the issue of fees. While a plain-vanilla passive fund may cost nothing, investing in private credit vehicles is expensive. Management fees range between 0.5% to 2%, and funds can take another 10% to 15% profit if they pass pre-determined hurdles. With the S&P 500 up 11.7% for the year, do wealthy individuals still want to stick around? Business development companies, a form of direct lending funds, on average generated 12.5% annual yield as of the first quarter, according to Fitch Ratings.

And how about reputation risk? A much larger client base brings in unwanted scrutiny. The prominence of Blackstone’s real estate product, which launched in 2017, resulted in equally high-profile media coverage over how it appraises the value of its assets. Is all that retail experimenting worth the trouble?

One concern with the rise of private credit is that this asset class may be embedding unknown risks into the financial system. We don’t know how much these funds have borrowed to juice up their returns, or what their loan covenants look like. Ironically, allowing mini-millionaires into this world can mitigate that worry, in that a few concerned citizens might be happy to share fund documents with the public and shed some light on this opaque world.

Courtesy Bloomberg/Shuli Ren