How market’s private credit crisis fears are spreading to bond ETFs

The private credit market is facing a crisis as firms dealing with less liquid and transparent bonds are grappling with investor redemptions. This challenge is emerging just as private loans are becoming more common in the ETF market. About a year ago, the Securities and Exchange Commission gave the green light to the first ETF branded as a private credit fund.

One positive aspect for ETF investors is that the risks associated with this asset class are being managed in a more controlled manner. ETFs that invest directly in private credit issues are limited in their exposure to the asset class, capped at 35%. On the other hand, older ETF products that indirectly invest in private credit through vehicles like business development companies and closed-end funds are facing challenges amid the current market conditions.

For example, the VanEck BDC Income ETF (BIZD), which holds assets worth around $1.5 billion and has been operating since 2013, has seen a 13% decline since the beginning of the year. This drop can be attributed to the fact that some of BIZD’s top holdings are publicly traded shares of private credit managers like Blue Owl Capital and Ares Capital, both of which have experienced significant declines in their stock prices.

Similarly, the Simplify VettaFi Private Credit Strategy ETF (PCR) has also faced a decline of approximately 20% over the past year. This ETF focuses its investments in business development companies and closed-end funds, reflecting the challenges in the private credit sector.

Liquidity remains a major concern for investors in the private credit market, as these investments are not designed for daily trading like ETFs. Private credit funds often restrict withdrawals during periods of market stress to prevent a “run on the bank.” In contrast, ETFs offer daily liquidity and trading options, although selling may come at a cost, such as selling at a discount to net asset value.

State Street has introduced private credit ETFs in collaboration with Apollo Global, providing investors with structured access to this asset class. The State Street IG Public & Private Credit ETF (PRIV) and the State Street Short Duration IG Public & Private Credit ETF (PRSD) aim to outperform standard bond benchmarks by including investment-grade private credit. PRIV can hold up to 35% in private credit issues, while PRSD’s holdings are a mix of government, mortgage, and currency securities.

Despite the challenges in the private credit market, ETFs have reshaped the fixed income landscape by providing investors with more targeted investment opportunities. As market volatility continues, ETF investors are adjusting their portfolios by moving from longer-duration bond funds to shorter-duration funds.

Overall, the private credit market poses systemic risks due to the mismatch between assets and liabilities. However, the design of many private credit vehicles limits liquidity, which can help mitigate risks over time. By allowing continuous trading with real-time price adjustments, ETFs contribute to market stability by reflecting stress as it unfolds. Both approaches aim to prevent disorderly outcomes and ensure the smooth functioning of the market during turbulent times.