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High hopes for private credit


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Good morning. I guess we’re just killing time and waiting for the Federal Reserve at this point? Well, while you wait for Wednesday to come, here are some thoughts on private credit and cryptocurrencies. Email us your thoughts on either: and

How does private credit beat the bond market?

Often I write headlines or section headings that end with question marks, even though I know the answer. This is not one of those times. I do not know how private credit beats the bond market, or even if it does, in risk-adjusted terms. It is pretty evident, though, that a lot of other people believe that it does, and that it will continue to do so.

We can see this belief in the fact that money is absolutely pouring into the asset class, with the explicit expectation that it will beat the dreary performance of the public debt market. Stories about this appear with thudding regularity in the Financial Times and elsewhere. The most recent was in Monday’s Wall Street Journal, which described how Ares Management has raised $8bn for a new private debt fund that will invest primarily in loans that back leveraged buyouts. It had set out to raise just $4.5bn, but what the hell. Where does all the demand come from? It ain’t complicated:

“More than anything, it’s about low interest rates,” said Kipp deVeer, head of Ares Credit Group. “A lot of investors are frustrated by the low yield in fixed income they’ve traditionally allocated to, whether it’s loans or government bonds or high-grade corporates.”

The frustrated investors include California Public Employees’ Retirement System, which announced last month it was so frustrated it was adding 5 per cent more leverage to its portfolio and changing its asset allocations as follows:

Calpers’ return target is 6.8 per cent. Junk bond indices are yielding 4.5 per cent. Triple-C bond indices (featuring bonds that are “currently vulnerable and dependent on favourable . . . conditions to meet financial commitments” in S&P Ratings’ words) yield only 115 basis points more than Calpers target. Frustrating! So here we come private markets, with a big chunk going to private credit. The Ontario Teachers’ Pension Plan is doing the same thing, for the same reason.

With private equity, we have a pretty good idea where the returns in excess of public markets once came from. They came from high leverage and from managing that leverage skilfully so it did not cause a meltdown during recessions. I used the past tense here because private equity as an industry has not outperformed public markets in the past decade (something of an achievement while using high leverage during a stonking, continuous bull market, but with the right fee structure the sky’s the limit).

Both private equity and private debt funds say that part of their excess return comes from an illiquidity discount. I’m not certain, but I suspect this is false. The primary customers for the private equity and debt funds — pension managers — actually prefer the illiquidity, because it comes with apparently stable returns uncorrelated with other asset classes, which is flattering to the pension managers’ portfolios. In other words, I believe managers pay more than they otherwise would for private markets’ illiquidity, because it brings with it returns that are not marked to market. My work has made me cynical.

If not illiquidity, then what is the source of extra returns? Executives at Apollo Global Management have something to say about this. Here is Marc Rowan, Apollo’s chief executive, on the company’s credit business, talking during an investor call:

“This is a fixed income replacement business. This is not an opportunistic credit business. Our goal in our [private debt] segment is to produce 150 to 200 basis points of excess return over the equivalent [publicly traded bonds] across the capital structure. We want to get paid . . . for illiquidity and complexity and origination, not for taking additional credit risk or assuming other risks.”

So higher return, less risk, because finding high quality private loans to make or buy is tricky, and Apollo is very good at it. Here is another Apollo executive, Christopher Edson, at a conference:

“There is no excess spread left in liquid [public] markets, so we believe that we need to originate [these loans] directly. This is basically manufacturing and creating the factory to generate these assets on an ongoing and recurring basis to drive excess spread and to effectively create these assets at wholesale prices . . . What are these origination platforms? They’re living and breathing companies. They have management teams. They have dozens or hundreds of employees.”

These Apollo-owned companies lend money to small companies, and lend against planes or rental car companies, houses and other assets. Apollo can earn 200 basis points more off these loans for the same risk level because, apparently, it’s just too hard for anyone else to supply the same customers with credit at the lower rates available in the bond market.

There are plenty of examples of tricky, niche markets rewarding enterprising investors with excess returns, but it is often argued that this is a reward for risk, not brains. The idea that there is a market inefficiency big enough to stuff hundreds of billions of dollars into is not naturally appealing to me, but at this point I’m not sure if I buy the private credit story or not. I’d be very interested to hear from readers with experience in the industry, or investing in it.

Revolution as crypto use case

What is crypto good for? A question with many answers, most of them unsatisfactory. On Sunday a new one was added to the list. From Bloomberg:

“A parallel government led by the supporters of Myanmar’s ousted leader Aung San Suu Kyi recognised tether as an official currency for local use after the group began fundraising for a campaign that seeks to topple the military regime.

“The National Unity Government officially accepts tether, a cryptocurrency meant to be a dollar proxy, for ‘domestic use to make it easy and speed up the current trade, services and payment systems’, NUG finance minister Tin Tun Naing said Sunday in a Facebook post. No other details were given.”

Tether, you’ll recall, is a stablecoin, meaning it’s ostensibly pegged one-to-one to the dollar. Some people have raised doubts about tether’s peg, but it has held so far. And that makes it useful, potentially, if you are an anti-government rebel group without access to a formal financial system which is itself in disarray.

Crypto diehards have long boasted that bitcoin and its brethren are independent of established systems, which is hyperbole. Crypto depends, to various degrees, on centralised exchanges, fiat-currency convertibility, internet infrastructure and so on. But the Myanmar episode hints that crypto does have a degree of systemic independence. Tether, or another stablecoin, might be just independent enough to help a resistance movement defy a disorganised junta.

Eswar Prasad, a Cornell professor and author of a new book on digital currencies (disclosure: I was a researcher on the book project), told us he thinks a broader shift is under way:

“I suppose the key angle [on the Myanmar story] is easy access to a dollar-equivalent payment instrument that has the benefits of not being in physical form, not being traceable in principle, and allowing for transactions without physical proximity of transacting parties. All for a good cause for a change.

“This development is along the lines of one prediction I have in the book — that currencies of small countries and those with non-credible central banks or currencies will face existential threats from digital versions of major currencies and from stablecoins.”

That is to say: while crypto is no dollar disrupter, the right one might cause serious trouble for the Burmese kyat, especially if the currency is debased by the government. If a stablecoin is stable enough, easy to deal in and resistant to state blacklisting, it could start looking better than the piddling official currency. Emerging markets with fragile currencies should watch out. (Ethan Wu)

One good read

A terrific Bloomberg piece about the fundamentally deceptive nature of environmental, social and governance ratings from MSCI and others. The ESG-industrial complex is just awful.

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