Should private credit be public?

0:09Rob Armstrong: Private markets get a bad rap and you know what? They kind of deserve it. These are markets where the investments are not on the stock markets. They're not normal company bonds that any big investor or canny individual investor can buy. They're things like loans packaged together by big alternative asset managers, often private equity firms. It's the stuff that's behind the velvet rope. It's kind of exclusive. And look, this whole thing is fine and it's been great for years. But the past year or so has actually been pretty rough. Investors have been trying to get their money out with patchy results.

0:47Rob Armstrong: But today on the show, is there a case that retail investors should be getting involved in this stuff after all. This is Unhedged, the markets and finance podcast from the Financial Times. I'm Pushkin. I'm Katie Martin, a markets columnist at the FT in London. I am joined down the line from his Brooklyn lair by Mr. Robert Armstrong,

1:09Katie Martin: sweating profusely, I understand, which is a mental issue,

1:15Rob Armstrong: a mental image for us all to work with today.

1:17Katie Martin: I just got back from walking my dog in the sticky humidity. So if I'm shining, that's why. It's because I'm good to my dog. Yes, yeah.

1:29Rob Armstrong: You've got to be good to your dogs, boys and girls. So, Rob, you've been writing about private markets recently. Let me just tell you some headlines on private markets recently that we've had on FT.com. So just a few weeks ago, BlackRock Private Credit Fund honours less than 40 % of redemption requests. So people can't get their money out necessarily from BlackRock Private Credit Funds. In May, the FSB, that's the Financial Stability Board, not the Russian Secret Service, raises alarm over private credit vulnerabilities. capabilities also in may ecb european central bank said private credit fueled ai boom poses a risk to the financial system so there's a bunch of reasons to not like private credit and not like private markets and this drumbeat i remember we first talked about this i think it was in september last year yes there was all of a sudden stuff started going wrong in this like fancy new market where nothing ever goes wrong and it's just been pretty relentless ever since hasn't it

2:34Katie Martin: September was the credit cockroaches. Do you remember the cockroaches where there were a couple of funds?

2:41Rob Armstrong: September 25.

2:42Katie Martin: Where there were a couple of private credit funds where something in the fund turned out to be either a fraud or something close to a fraud. And nobody had done their proper due diligence on this loan. And when something like that happens in a very public way, everybody starts wondering what else might be a fraud behind the velvet rope, as you put it well, there. And that put a kind of scare into the market, a scare, I should say, which hasn't totally materialized in the credit results of the industry at large. It was sort of the dog or the cockroach that didn't bark. I don't know what sound cockroaches make.

3:24Katie Martin: I don't think they bark.

3:25Rob Armstrong: They hiss. They hiss. They don't bark.

3:26Katie Martin: And it was the cockroach that didn't hiss so far. Exactly.

3:31Rob Armstrong: So some people that you talk to are like proper kind of disaster merchants about private credit. They're like, there is like billions and billions and billions of dollars tied up in private credit. And we don't really know what's in the box. But we suspect that there's lots of lending to unsustainable software companies that's in the box. And this is all terrible because you can't necessarily get your money back quickly. If you put money in a private credit fund, you can't necessarily get it out again. Look, these people, they could be right. Yes. But the evidence for this being a systemic risk to the entire global financial ecosystem is at best weak.

4:10Rob Armstrong: Like, where's the problem? So where do you fall down on this?

4:13Katie Martin: I think with private assets, there is a bunch of kind of overlapping worries. and it's important to kind of pull them apart. So let's start with one that you mentioned when you were reeling off those headlines, which is this thing about liquidity. So the point about private assets, private credit, private equity, whatever, is that part of the secret sauce is the manager of the private fund owns this stuff for a long time. It stays in there and it's not exposed to the vicissitudes of markets and it doesn't have to deal with all the complexity, whether it's loans or it's equities or it's a company or whatever.

4:56Katie Martin: It doesn't have to deal with the vicissitudes of the public market. But that means that unlike a fund that has marketable stuff in it, if you want your money back, you might not be able to get it. Right? And they have what is called gates, which means the standard gating system is something like this. every quarter, 5 % of the private fund's assets can go out the door. And the private fund will try to keep enough cash around in the bucket. So if 5 % of the people want their money, there are some liquid assets to fulfill that wish. The problem is, if 5 % of the people want their money, probably 10%.

5:37Katie Martin: And you know what happens when 10 % of the people want their money? 20 % want it. Demands for liquidity don't drip along. They spike and they trench.

5:46Rob Armstrong: And it's important to remember as well. So a lot of sort of mainstream types of funds, you know, I'm thinking of like mutual funds or money market funds or ETFs or whatever. You've got whatever, you know, a thousand pounds, a thousand dollars parked in an ETF somewhere that's like exposed to, I don't know, the US stock market. If you want that money back, You click a button and you can get all your money back. You know, fine, just no problem. You can do this instantly. You press a button and it comes back to you. It might take a few days to clear through your account, but you can have it back.

6:18Rob Armstrong: These private funds, you can't do that. And for a lot of people, this is like a red flag. And it says, you know, this is dodgy in some way. This indicates that there's a difference between how easy it is to sell the underlying assets and how easy it is to liquidate your investment. And that makes this all unstable in some way. But it's really important to remember that the gates are a feature, not a bug.

6:41Katie Martin: That's the whole point. Exactly.

6:43Rob Armstrong: Is that you can't just jump in and out of private market investments because precisely that they're not liquid. You can't just sell them immediately.

6:54Katie Martin: Illiquidity is the point. These are assets that are not are not ideally suited to being bought and sold on a daily basis. Maybe it's a company that is in its development stages or being restructured back there. Or maybe it's, you know, it's a loan for, you know, a company that is in a similar situation, whatever. The whole point of this stuff, the extra returns this stuff promises over public markets is all grounded in its illiquidity. And by the way, another feature of the Gates is it says that right on the tin. It's not like they're tricking you into thinking that you can get your money out.

7:34Katie Martin: They say right at the beginning. And I don't think I think it's important not to be too paternalistic on behalf of retail investors. You know, as I said in my column, we're letting people buy SpaceX. Right. If you are sophisticated to buy Elon Musk's AI slash space exploration slash fantasy machine, I think you can handle buying something where you can't get your money back instantly. And by the way, normal people own houses for a long time. They buy certificates of deposit, et cetera. They buy insurance policies. So like the average retail investor, I think, can be trusted with a little bit of illiquidity.

8:17Katie Martin: but wait wait i've got the big but it's coming wait oh the related worry to the liquidity thing is that it makes people worry that the manager of the fund is saying the stuff is worth something that it's not really worth right if you don't have the market functioning as a pricing device every day and saying here's what this bond is worth here's what these stocks are worth here's what this company is worth, there is a certain amount of discretion the fund manager has in marking the value of the assets. And there is, for good reason, some worry that the fund managers at times might be a little kind to themselves in how they mark the book.

9:00Rob Armstrong: Yeah. Like if you said to me, so Katie, what's your house worth? I would say,£11.10 bazillion.

9:07Katie Martin: And you've got no way of proving whether or not my house is worth

9:14Rob Armstrong: £11.10 bazillion unless I sell my house. And I can't sell my house overnight, despite the very upbeat property market in Walthamstow. So it is a trust thing. You have to believe me when I say

9:28Katie Martin: it's worth 11 it's not complete trust there have been incidents where private funds drift away from where public markets are going like everybody knows what the bond market is doing and if you're claiming that your private credit fund is completely disconnected from the bond market the market will call bs on you and how they do that is they ask for the money they're like oh you're you're you're a private bond fund is suddenly worth 25 percent more relative to the junk bond market, great, I'd like to sell right now. Right? I mean, give me that higher valuation, and I'll go out and buy bonds. So there's, you know, the private fund managers are constrained by reality, but not completely controlled by it.

10:11Katie Martin: So that is an issue that you have to deal with.

10:14Rob Armstrong: So all of these issues, some of them are just like structural, that's like the whole point of how this market works. And some of them are sort of issues that have like bubbled up over the past year or so, like you say, some companies that have been lent to by private markets turned out to be problematic. People started asking for their money back. They couldn't get their money back. There was a bit of a kind of have these, did people understand the risks when they bought these things? And I agree with you, just learn to read.

10:42Katie Martin: Oh, now you want people to read, Katie. What's next? You're going to make them add.

10:50Rob Armstrong: This is like on the documents, like it's not a secret.

10:54Katie Martin: No, you can't have your money back tomorrow. Yes. Yeah.

10:57Rob Armstrong: And also these people, when we say that this has been sold into retail, they're not like retail, retail. They're not like normal people like me. They're like, you know, they're pretty wealthy individuals who can afford to lay down like a hundred grand here or there.

11:12Katie Martin: Yeah. Most of these funds are aimed at investors who have a financial advisor and they've been sort of vetted as investors who can handle a certain amount of complexity. They're not quite yet selling this, you know, just like you buy it by pressing a button in your Robinhood account. But you can believe that the private assets industrial complex is aiming for that. We are going that direction. A thing that we know is happening is that the big, what they call alt asset managers, Blackstone, KKR, Apollo, et al., they've slightly run out of institutional investors to sell this stuff to. And the biggest pile of money in the world is the pile of money held in U.S.

12:01Katie Martin: retail retirement accounts, 401ks and stuff like that. And you can be darn sure that is a target that the alt investment industry is not going to stop shooting at.

12:14Rob Armstrong: Another mahusive pile of money that lots of different types of asset managers would like to get some access to is you look at the UK and Europe. We're like terrible at this stuff. We keep money on deposit, earning like nothing, just sitting in current accounts. I don't know why we do it. Drives like regulators and markets people over here absolutely crazy. But there's like trillions of euros sitting in bank accounts earning nothing. And the financial industry is desperately trying to figure out how to get these people to at least put money in, I don't know, like bonds or something. But anyway, so you say like the private markets industry is like running out of institutions to sell to.

12:54Rob Armstrong: They're looking for kind of – That's a slight exaggeration but only slight. It's slight but only slight. And hey, it's a podcast. We can get away with this. But so another headline on private markets that came through just in early July was that big investors have committed billions to private credit despite the turmoil. So there's been enough bad headlines about private credit that actually it's got quite nice and cheap. So actually, that's the point at which some big institutions start saying, OK, this is soft enough. I will buy it. That's quite interesting, don't you think?

13:27Katie Martin: I think it's very interesting. And it shows that the institutional investor community is still quite keen on this stuff. And this raises what I think is kind of the super question about this asset class. Is it magic? So there's this idea that if you buy this illiquid stuff through a fund run by an all asset manager, you are going to get a premium over what you could get in the public markets. So, you know, whatever, 100 basis points, 200 basis points, you're going to earn extra.

14:02Rob Armstrong: And so that's one or two percentage points.

14:05Katie Martin: Yeah, something like that. Where does that come from? And this is like a long running debate. Does it come from the fact that these assets are very tricky to manage and really tricky to find? So smart people who can manage them and find them can wring extra return out of them. Are you getting paid for just that illiquidity? Does that come with a bonus? Perhaps. And the debate goes on. So the question is, is that premium real? Is it going to continue to be real? and can retail investors reap it if they are included in this game? But the extra returns are only part of what institutional investors like this stuff for.

14:49Katie Martin: They like it because it makes their portfolio as a whole look less volatile. One of the very nice things about a private asset is that its price doesn't change day to day. So you're sitting there and you're running the Katie Martin Foundation with a gajillion dollars that you earned by selling your especially expensive house. And if you have private assets in that portfolio, those private assets don't move around every day. And that makes them look uncorrelated with the public assets. And it makes the whole thing look like a calmer portfolio. And so like, as if by magic, adding private assets makes the whole portfolio look more attractive as a package.

15:32Rob Armstrong: This may be crazy, but the only reason the price doesn't move every day is because it's not on the market.

15:39Katie Martin: The value of your house does go up and down every day. You just don't know because it doesn't have a ticker on the front of it. But retail investors shouldn't care about that. I mean, so anyway, it's another issue out there.

15:52Rob Armstrong: And you, like, judging from some stuff that you've written recently, your view is that we should be a little bit less nervous about allowing retail investors into this stuff. Like, you know, yes, there are kind of, there are risks here, but there are risks in stock markets. Yes. And God knows there's risks in crypto, which people unaccountably buy. So, you know, why can't they take risks in this instead?

16:16Katie Martin: Yes. As you know, Katie, I'm a libertarian American nutjob. and I think people should be allowed to buy what they like, you know, within reasonable ground. So basically that instinct in me says, you know, with some sensible rules about saying what is in the product

16:35Rob Armstrong: that is being bought, being very clear about terms,

16:38Katie Martin: all of that stuff. And I think disclosure on these things could be better, by the way. I think it's okay. But there is a much bigger problem that we haven't talked about yet, which is how much it costs to invest in this stuff. So it always comes down to fees for me where retail investing is involved. And these products, these retail private asset products are expensive. So the big ones, they'll charge you a percent and a quarter just for the privilege of buying the thing. So if the industry really wants to sell this stuff to retail, they've got to find a fee structure that makes sense. It's not to say that it's ever going to be as cheap as an S &P 500 index fund.

17:21Katie Martin: It's not.

17:22Rob Armstrong: It shouldn't be either because of the liquidity thing.

17:25Katie Martin: Yeah, and it's tricky and you have to source the assets. So there's expenses that have to be paid.

17:31Rob Armstrong: But, you know, the reports of the death of private credit have been greatly exaggerated. It's clear that the institutional demand is still there. And there is a universe where it could work for a broader range of people. You know, I just don't have anywhere near enough money to consider this. But, you know, maybe if you're listening, maybe you do. Rob, we are going to come back in just one second with Long Short.

18:08Rob Armstrong: Alrighty, it is time for Long Short, that part of the show where we go long a thing we love or short a thing we hate. Rob, what are you saying?

18:16Katie Martin: I'm going to go short the Odyssey, Katie.

18:18Rob Armstrong: Are you?

18:19Katie Martin: We have this movie coming out. And so there's like Odyssey and Odysseus fever sweeping the world. And it has always been my very strong view that the Iliad is twice as good a book as the Odyssey. And we should only be thinking about the Iliad all the time. And the Odyssey is a footnote. Achilles is more interesting than Odysseus. I'm short Odyssey, long Iliad. It's a pair trade.

18:46Rob Armstrong: It's surprisingly cerebral.

18:49Katie Martin: For an American libertarian nut job, I think that's pretty impressive.

18:55Rob Armstrong: I'm gonna go long air con stocks. So air con stocks are doing incredibly well for obvious reasons.

19:04Katie Martin: Yes.

19:04Rob Armstrong: I keep not being allowed to talk about the weather. But nonetheless, some air con stocks are 40%. Like, you know, the world has kind of got the memo on this. And this includes, yes, a 40 % rise in a company called Madison Air Solutions, which makes brands such as big ass fans.

19:29Rob Armstrong: I presume it's big ass fans and not big ass fans. No, that would be different.

19:34Katie Martin: No, I think it's a big ass fan. It's not a fan for your big ass. If that's what you are in the market for. Yeah.

19:44Rob Armstrong: I don't think that's how it works. But yeah, I like the idea that the manufacturer of big-ass fans, its stocks are up 40%. This is good. But also, I don't know if you saw, Eurostar operates the trains between the UK and Paris and Brussels and other places. It's just ordered a bunch of trains that can cope with Saudi summers of up to 55 degrees.

20:07Katie Martin: Man. I just hope that they, you know, what we do in the summer in New York, we just go to the movie theater and sit in a nice cold movie theater. That's the way to handle it.

20:18Rob Armstrong: And go and watch Odysseus.

20:22Rob Armstrong: Listeners, please do not overheat. Share your thoughts on the Greek classics at unhedgedft.com. We'll be back in a couple of days. So listen up then and tell your friends. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forehead. Special thanks to Laura Clark, Greta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free and a 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

21:17We'll see you next time.