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Thursday marked an almost moon-landing level event on Wall Street. An exchange traded fund partially including illiquid private credit, managed by State Street and affiliated with Apollo Global Management, started trading with an unprecedented level of flexibility for investors.
By the evening, the US Securities and Exchange Commission had written a letter casting doubt on how the plumbing worked. It even wondered if the ETF could fairly utilise the branding of Apollo, where, by coincidence, former SEC chair Jay Clayton happens to be on the board.
The more grave concerns from the agency relate to how private assets can be valued each day and whether the complex liquidity mechanism created by State Street would work in a crunch. Private capital firms hope such products will bring in retail investors and fuel the next wave of industry asset growth. But even the most advanced financial engineering may not be able to solve the almost immutable laws of financial markets.
A JPMorgan investment grade bond ETF charges 40 basis points for exposure to widely-traded fixed income securities. The State Street/Apollo fund, costing a rich 70 basis points, is also focused on high grade instruments. But it includes so-called private credit, debt that does not appear in a traditional marketplace, including direct loans to corporations and “asset-based” securitisations for, say, aeroplane financings. Asset managers, not banks, increasingly underwrite such credit.
According to marketing materials, 80 per cent of the State Street/Apollo fund must be in investment grade securities in both public and private credit, including Apollo-originated loans. Separately, up to 15% of assets can be in illiquid investments.
Previous existing retail private capital products limit investors’ ability to quickly pull funds out. Those from Blackstone, for example, allow exits once a month, capped at a small percentage of overall fund assets. The State Street/Apollo ETF has, in contrast, agreed to put in at least daily bids for the fund’s Apollo-sourced private debt assets. It will also repurchase assets “subject to, but not limited to, contractual levels designed to cover the estimated seven-day stress redemption rate”. The regulator wants to know if this Apollo backstop is good enough to maintain liquidity.
Private credit was supposed to derive its superior returns by forcing holders to buy and hold to maturity. That suggests there ought to be a trade-off for investors, where liquidity comes at a cost — be it fees, or lower returns. The State Street/Apollo ETF presents the impression that they have found a way to square this circle. The SEC inquiry, on the other hand, suggests maybe they have not.
