Private Credit Investments - thoughts?

[Duskerdawn]

Have been reading alot of articles on it and the feel like it's the next biggest investment bomb/ponzi (i.e. similar to subprime mortgage meltdown in 08/09)...

https://www.bloomberg.com/news/features/...epage-asia

"Rowan, who’s widely seen as the pioneer of private equity’s push into insurance, argues the premium comes from private credit’s illiquidity, or the difficulty of selling it quickly, not its risk of default."

I think the main issue of Private Credit although it has "low risk of default" is that there is no price discovery which causes more severe defaults when they happen.

Additionally the reason for growing demand is due to messaging and also incentive structure of private credit sales.

What he doesn't tell you is that for every dollar of investment brought into Private Credit often pays out a higher amount of commission/kickbacks. The incentive to sell them is what brings about the premium. As munger indicated "show me the incentives and I'll show you the outcomes".

In addition to the above, if you search the keywords "private credit + payment-in-kinds (PIK)" and understand that PIKs is just a form of accounting magic to book profits for debt that is not paid. You will be able to see the ponzi structure where Private Credit books accounting profits from interest that is not paid and the fund pays out from the new investors into the funds.

While I note that not all Private Credit funds are Ponzi schemes, a large number of them have the above elements and have the same symptoms of swashbuckling salesmanship similar to the pre-08/09 marketing of MBS.

Hence, it's once place I wish to call out and hope to bring attention to and if you have any additional points to add, please do.

Edits to above 10 sep - corrected some minor misinterpretion.

[weijian]

Read a recent Jason Zweig's article that commented that almost everything that can be ETF-ed has been ETF-ed, including an ETF that aggregates companies kicked out of S&P500 ETF.

So, it is probably no surprise that salesmen/middlemen continue to find new ways to milk the ultra-liquidity that Fed's money printing has bought about.

Not sure about private credit been the next big "boom/ponzi". On the local front, we witnessed the Sunshine Empire ponzi more than a decade ago. Then a few years ago, the Nickel trading ponzi happened. The business model is the same, ie. preying on the greedy (not naive, but greedy). So, the next ponzi will happen but the vehicle of choice will probably be the asset class of the day.

Fund giants aim to bring private markets to retail investors – but mind the risks

Even more interesting is news that Apollo Global Management is partnering State Street Global Advisors to bundle private credit into an exchange-traded fund (ETF). The fund is expected to be invested mostly in investment-grade debt. To be sure, the liquidity mismatch between an ETF with daily liquidity and private credit is not lost on observers. The private debt exposure may well be indirect via derivatives.

Wealth advisers will surely welcome these developments, which open up yet more options for clients and a lucrative source of fees.

https://www.businesstimes.com.sg/wealth/...mind-risks

[weijian]

Howard Marks made his fortune primarily through credit. He specializes in distressed assets/high yield bonds, and so private credit as an asset class, is his competition. I would assume he has thoroughly sized up his competitors.

Gimme Credit

For me, the most important observation about private credit is that it mostly emerged since 2011 in response to banks’ reduced lending activity after the Global Financial Crisis. Since then, the economy has witnessed an unusually long string of years without a recession (if you don’t count the two-month Covid 19-related recession that flared up and was reversed in mid-2020). To paraphrase Warren Buffett, the tide has never gone out on private credit, meaning we haven’t had an opportunity to see its flaws. As far as I’m concerned, the main one is the possibility that some managers have been in such a hurry to scoop up capital and put it to work – so they could come back for more – that they relaxed their credit standards and failed to demand a sufficient margin of safety. If there’s ever another difficult period in the economy and the market, we’ll see the result. Note: this isn’t a sweeping concern about the loans themselves, just a question about the behavior of individual managers.

Connected to the above (and to the absence of marking to market), we don’t know what’ll happen if and when a difficult environment does arrive. Is there a limit on the ability of managers to keep marks too high? Is it right for fund returns to ignore deteriorated fundamentals? Can managers avoid recognizing credit difficulties by granting forbearances and “kicking the can down the road”? For how long? Are there ill effects on fund investors in the meantime? Since private credit managers are mostly unregulated, will the truth come out? Which truth? Questions like these also are answered only when the tide goes out.

Lastly, I don’t believe private credit represents a systemic risk. People have been on the lookout for systemic risk ever since the GFC, in which troubled banks brought trouble to other banks and took them down. My belief is that the risk in private credit isn’t systemic, since (a) private loan portfolios and their owners aren’t levered nearly as much as banks were in 2007-08 and (b) there isn’t the same level of interconnectedness, or “counterparty risk,” since the holders haven’t sold each other default protection and other forms of hedging, like banks did before the GFC. There are those who believe some holders of private credit have multiple layers of leverage, which could increase the risk in a downside scenario, but I have no way of knowing.

https://www.oaktreecapital.com/insights/...mme-credit