Private credit’s stale pricing problem
More frequent asset valuations can boost market resilience and investor confidence
Huw van Steenis
“Progress is cumulative in science and engineering but cyclical in finance,” the financial writer James Grant once quipped.
Financial innovation can solve problems but it also tends to bring back old risks in new guises, forcing investors and regulators to relearn how they play out when markets turn.
That pattern is now evident in parts of the private credit market, where stale pricing, opaque valuations and concentrated debt exposures — notably to software — are beginning to test investor confidence.
There is at least one clear lesson: more frequent pricing and greater transparency are essential to market resilience.
Stale net asset values can exacerbate redemptions in periods of stress.
If investors with a short-term mindset believe NAVs are significantly lower than the last outdated reported figure, they have a clear incentive to redeem holdings to take advantage of the higher value while they can.
This creates a classic first-mover advantage.
The longer-term investors who stay in the game may suffer if redemptions spur fund managers to sell assets quickly, making a bad situation worse.
This appears to be a current risk with business development companies, closed-end investment funds which are used for private credit.
Some 26 per cent of private credit focused BDC portfolios are to software and services companies, according to Morgan Stanley Research.
That compares with just 3 per cent in the US High Yield index.
Of course, these loans were struck BC: that is, Before Claude, Anthropic’s AI agent.
With AI tools threatening the sector’s earnings, investors are naturally reassessing positions — particularly vintages from 2021, when buyout activity peaked in an era of near-zero rates.
We will have to wait and see how much of an impact AI has had on software companies and the value of the loans made to them, but some investors are footloose, seeking redemptions.
As a result, a number of managers have begun to apply “gating” provisions to funds — features that limit or defer such redemptions.
These include Ares, Apollo, BlackRock’s HPS, Morgan Stanley, Cliffwater, Blue Owl and Blackstone.
Greater reporting frequency for NAVs would reduce the incentives for shorter-term investors to rush for exits and give more protection to longer-term investors.
Funds would still gate in times of stress but more timely, accurate valuations should reduce pressure to do so as managers of funds would find it easier to sell assets at those levels if appropriate.
While gating may be unpopular with some investors, it is crucial for sound asset-liability management and investor protection.
More regular NAVs would also help the banks providing fund finance, which are now applying blunt anticipatory “haircuts” to the value of their software sector exposures, as they doubt the last reported figures.
There is also nothing inherent about the private credit asset class that prevents more regular NAVs, though pricing conventions would need to evolve.
For instance US municipal bonds don’t trade frequently but are regularly quoted.
There are signs of progress.
For instance, Apollo is partnering with Intercontinental Exchange to create a data platform for private credit.
This is intended to collate information on deal activity with authorised counterparties without exposing proprietary data.
This could help companies with creating monthly or even daily NAVs supported by third-party checking.
Writ large, this is part of a convergence in practices in managing public and private assets.
More broadly, it is important to consider the issues of private credit in context.
Most of the headlines about difficulties in private credit involve non-investment-grade debt.
Yet some 43 per cent of the largest private credit companies’ activity serves insurance companies with investment-grade products, according to Oliver Wyman research.
And some recent problems at companies like Tricolor, First Brands and the UK’s Market Financial Solutions were idiosyncratic, involving alleged fraud.
The majority of exposures in those cases have been to banks, though some private credit firms have had their fingers singed.
Still, the other history lesson is hard to escape.
The fundamentals of credit investing — disciplined underwriting, diversification and prudent risk management — matter as much as ever, whether public or private.
“For practical purposes, the financial memory should be assumed to last, at a maximum, no more than 20 years,” John Kenneth Galbraith observed.
After all, markets do not punish innovation.
They punish forgetfulness.
The author is vice-chair at Oliver Wyman and former global head of banks and diversified financials research at Morgan Stanley
0 comments:
Publicar un comentario