Private credit in an ETF wrapper

The funds seek to capitalize on the growing private-credit market, while offering added liquidity. Alternative assets data provider Preqin projects global private credit assets under management (AUM) to balloon to US$2.8 trillion by 2028 from US$1.5 trillion in 2022.

“The private-credit market has been growing very quickly, and the liquid private-credit market has grown significantly over recent history,” said Julian Klymochko, CEO of Accelerate Financial Technologies Inc. in Calgary.

Private-credit ETFs in North America

Private credit emerged in the wake of the global financial crisis as an alternative to traditional bank and public market lending.

It has grown into a multi-trillion-dollar market run by large asset managers and private-equity firms. Investors can choose from a growing list of products that provide exposure to private credit, particularly in the U.S.

Klymocho’s firm bills itself as the first in Canada to launch a private-credit ETF.

The Accelerate Diversified Credit Income Fund (TSX: INCM) and a U.S. dollar version of it, (TSX: INCM.U), hit the market in May 2024. To date, the fund, which has a 0.75% management fee, has gathered more than $50 million in AUM.

INCM aims to generate a 10% yield, paid monthly, by providing exposure to a portfolio of primarily secured, floating-rate loans through allocations to business development companies (BDCs) and private-credit managers.

“We’re not actually underwriting the portfolio. We acquire private-credit funds from leading U.S. private-credit managers in the secondary market, and we aim to do so at a discount to their net asset value,” Klymocho explained.

“So, we buy liquid private-credit funds and trade in the secondary market for the funds.”

Accelerate selected the 20 fund holdings based on several metrics.

The firm generally only considers private-credit funds with more than $500 million in equity market capitalization and more than $1 billion in loans in their portfolios, Klymocho said. It also looks for funds that lean toward senior secured loans and floating-rate loans, have a track record of “attractive” loan underwriting and consist of at least 100 loans “such that if one loan does experience a credit event, it won’t overly affect that credit fund’s net asset value too greatly,” he added.

Accelerate launched INCM to address issues in the traditional Canadian private debt space, such as illiquidity and fund concentration. It also wants to provide investors with another tool to diversify their portfolios since fixed-income investments have underperformed due to higher interest rates in recent years, Klymocho said.

The firm is the first in Canada to launch an ETF that provides indirect exposure to private assets through BDCs, said Andres Rincon, managing director and head of ETF sales and strategy with TD Securities Inc. in Toronto. Such products exist in the U.S. too, including the VanEck BDC Income ETF (NYSE: BIZD) and Putnam BDC Income ETF (NYSE: PBDC).

“What Accelerate gives you is exposure to BDCs, which are really offshoots of many of these companies that have private assets,” Rincon explained. “They give you exposure to [private credit] in an indirect way, through a vehicle that trades on an exchange.”

He likened this to how investors have long been able to buy stocks such as KKR & Co., Inc. and Brookfield Corp., thereby giving them access to publicly listed companies that are “very heavily invested” in private assets.

However, Rincon noted that the Accelerate ETF is unlike what U.S. asset managers like State Street Global Advisors and Apollo Global Management are proposing. The firms are seeking regulatory approval to launch an ETF that provides some direct exposure to private assets. BlackRock Inc. is also eyeing these products.

“This has not been done anywhere in the world yet,” he said.

“In my opinion, [INCM] is a great segue for the industry to launch ETFs that give you direct exposure to private assets. This is part of the evolution.”

Dan Hallett, vice-president, research and principal with Oakville, Ont.-based HighView Financial Group, said caution is warranted when it comes to these products.

“Even though this is all housed in an [ETF] structure, investors and advisors have to understand that ultimately, liquidity is driven by the underlying exposure,” he said.

Who should invest in these funds?

Private-credit ETFs are appropriate for investors who are seeking a higher yield solution, want to diversify their portfolios and are willing to take on a “moderate amount of risk,” Klymocho said.

“The higher the yield, generally the greater the risk. Our ETF does carry that medium-risk rating.”

Suitability depends on various factors. But these funds “would be more attractive” to people who are aiming to achieve a higher yield than they can get in the traditional investment-grade credit market and don’t mind investing in a “slightly riskier set of assets,” Rincon said.

Speaking specifically about INCM, Rincon said that it provides an opportunity for investors to access illiquid assets through a more liquid vehicle.

At the same time, he stressed that the underlying BDCs in the ETF have limited liquidity compared to other publicly listed securities because there is limited availability of BDCs. So, if an investor seeks to make a large-scale redemption from a large private-credit ETF holding BDCs, they would have a harder time doing so than, say, exiting a large-cap stock, because BDCs are subject to more limited demand and supply.

“For most Canadians and most investors that are looking at small size [positions in these ETFs], it’s fine. It’s more when you start getting into large positions and there’s limited liquidity, it’s a little bit harder … and takes longer to get out,” he said.

Hallett said this is not a product he would recommend to most people due to the higher level of risk that comes with investing — directly or indirectly — in private assets compared to public assets and because its underlying leverage is “not that apparent.”

He recommended advisors really consider what purpose these vehicles would serve in a portfolio, noting that “there are a lot of important details when you pop the hood and do some due diligence. … It’s not to say that nobody should have alternatives. It’s something to be entered into thoughtfully and carefully.”

Hallett also noted that private-credit ETFs can be sensitive to economic conditions and market volatility, since their success depends on the performance of the companies they invest in. In turn, this can impact the liquidity of these funds and “spreads are going to be very wide” in market downturns.

“Liquidity can diminish significantly or periodically just disappear in really tough markets,” he said. “It doesn’t mean the ETF wouldn’t trade, but then you’re paying a price to find liquidity where otherwise you wouldn’t be able to access it.”

The outlook for private-credit ETFs

Klymocho’s firm is “very bullish” on private credit.

“It’s one of the fastest growing asset classes and it’s appealing to investors, given the around 10% yield one can obtain via senior secured lending,” he said. “So you’ve got equity-like returns with credit risk.”

While private-credit ETF options are still limited, since Accelerate introduced its fund, several ETF issuers in the U.S. have launched or proposed similar products, Klymocho noted.

Rincon expects to see more, including ETFs that provide more direct exposure to private assets, but said this will be a gradual process, subject to regulatory hurdles.

Hallett said private-credit ETFs will continue to perform well, “as long as stock markets are good and credit markets are good.”

This article appears in the February issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.