Over the past decade, private credit investments have become popular. The Federal Reserve Bank of Boston described the rise as “meteoric.” Private credit investments can take many forms. All these investments are risky. The most recent type of private credit investment is the private credit ETF. Such investments pose an even larger risk due to unique characteristics and a recent push to sell such investments to retail investors.
Private credit ETFs enter a space that was once reserved for banks. That space is the lending of capital to small or high-risk companies. While banks are structured to weather such lending risks, the replacement of these banks with private investors poses some challenges.
One such challenge is the discrepancy in liquidity between the investment vehicle and the underlying asset. ETFs are extremely liquid, are sold as liquid investments and may be traded throughout the day, while the underlying private assets of the ETF are illiquid, creating a liquidity mismatch.
Such liquidity mismatch creates the potential problems for fund managers. This problem is that fund managers may be unable to meet liquidity requests in the face of a triggering market event. If that happens, the investments could become worthless or bankrupt. These investments often lack a backstop to prevent some type of run on the investment.
Additionally, investor advocates identify other risks to retail investors of these risky ETFs. These advocates identify that no one knows the true worth of the loans due to the loans being private being made or whether they are hiding loans in trouble.
Over the past 20-plus years, Jeffrey Pederson focused his practice on the representation of investors. Please contact us with questions.
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