Private credit is deliberately illiquid — did advisors explain that?

From his seat as investment head at Nomura Capital Management, Matthew Pallai maintains that many of the fears about private credit are exaggerated. 

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But he also thinks many financial advisors may have to reconsider how they present these often lucrative but also illiquid investments to retail investors.

Concerns about lending outside regulated bank channels have arisen in recent months as investors have sought to pull billions out of private credit funds. Those requests at times have led big asset managers like Blue Owl and BlackRock to invoke redemption limits, often restricting withdrawals to 5% of a fund’s total value in a quarter.

Like many asset managers, Pallai thinks a chief attribute of private credit and other alternative investments is their insulation from the market gyrations that can send stocks and bonds soaring or plunging in response to daily news. But in order to get that benefit, investors have to accept some barriers to taking money out. The key for wealth managers is to explain that trade-off clearly.

“Even though they may have said it up-front, and I’m sure they did — because there are rules around the marketing materials — they probably should have said it more often and said it louder,” Pallai said. “And even though they made the case, it may have been good to remind investors on a quarterly basis.”

Redemption limits a feature rather than a bug

As chief investment officer at Nomura Capital Management, a U.S. subsidiary of Tokyo-based financial services giant Nomura Holdings, Pallai helps wealth managers and institutional clients pick among the many opportunities they have for investing in private markets. He said he sees private credit funds’ redemption gates as a feature, not a bug. 

“The only way to deliver more than that 5% would be sell illiquid stuff, probably at prices that you don’t want to sell at,” Pallai said. “And that would be bad for both investors leaving in a hurry, as well as investors staying.”

But that doesn’t mean financial advisors took the trouble to list both the pros and cons of private credit funds when they were recommending them to clients. 

Scott Bishop, a partner and managing director at the Houston-based advisory firm Presidio Wealth Partners, said the recent anxieties have given him and his colleagues an opportunity to remind clients why they got into private credit in the first place. He said he has been hearing more from investors in recent months about their private credit holdings. But so far he hasn’t seen anything suggesting a “rush for the exits or full-blown liquidity crisis,” he said.

“For the right investors, private credit can still play a role in portfolios,” Bishop said. “But this is a moment that reinforces why private assets require patience, diligence and a clear understanding of what you own — especially when market conditions become more challenging.” 

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BDCs returned $7.4B to clients in Q1, left $6.5B behind redemption gates

So far, private funds have lived up to their obligation to return money to investors. The investment banking and private market-tracking firm Robert A. Stanger reported earlier this month that publicly registered business development corporations, often the conduit for private loans, were able to return more than $7.4 billion to investors in the first quarter.

It’s an accomplishment that pales a bit, though, in light of the fact that investors had actually sought to pull out $13.9 billion in total. In other words, the funds’ redemption gates meant $6.5 billion remained inaccessible.

Like Pallai at Nomura, Stanger CEO and Chairman Kevin Gannon described the automatic cutoff of withdrawals as a feature, “not a flaw.”

“The fact that sponsors were able to deliver this level of liquidity within the defined program limits demonstrates exactly what these structures were built to do,” Gannon said.

Where concern about private credit comes from

Private credit funds started drawing heightened scrutiny in recent months following the collapse last year of the auto industry firms Tricolor and First Brands, both of which had secured substantial loans outside the regulated banking system. Artificial intelligence also delivered a blow when code-writing models released by tech giants like Anthropic and OpenAI seemed to pose a threat to long-entrenched software firms.

On Friday, the software firm Medallia announced it could not repay $3 billion in loans taken out from the financial services giants Blackstone, KKR and Apollo Global Management, The Wall Street Journal reported Friday. Blackstone has said the proportion of nonperforming loans — loans in default or close to default — now makes up 2.4% of the $80.5 billion held in its largest private credit fund, BCRED.

Pallai at Nomura said most of the concerns about private credit have centered on corporate direct lending, a market valued at roughly $1.8 trillion. Of that, roughly $400 billion has gone to purposes related to software, he said.

So there are legitimate reasons for concern, Pallai said.

“I think in this case, there are going to be some winners and losers,” he said. “But it’s going to take a while to figure out how that is measured — realistically years, not months.”

Ultrarich or mass affluent, Merrill, Wells Fargo, Goldman are all into alts

Little to worry about, Wall Street says. Regulators aren’t so sure

Wall Street has been hesitant to sound alarm bells. Morgan Stanley CEO Ted Pick said in an earnings call this month that the firm’s financial advisors have only 5% of their clients’ portfolios in alternative investments and only 1% specifically in private credit. In a reassuring development, Pick said that institutional investors have shown a willingness to step in and buy private credit assets that retail clients are trying to sell.

Yet despite such assurances, regulators have their antennae up. Securities and Exchange Commission Chairman Paul Atkins said earlier this month that his agency is closely monitoring the “emerging pressures” in private credit.

“Let me be clear that opacity in this space can be an issue,” Atkins said on April 21 in remarks delivered at the Economic Club of Washington, D.C. “That valuation, transparency and credit quality are key.”

401(k) plan advisors warm up to alts — with one exception

Investors prefer venture capital, growth funds to private credit

Retail investors also aren’t oblivious to the recent headlines. From a survey of 390 wealth professionals last fall, the asset management firm Hamilton Lane reported in January that nearly 90% of the respondents planned to increase their clients’ allocations to private markets over the coming year. But when asked about specific types of private investments, 37% said they plan to decrease allocations to private credit, and only 36% said they would increase them. 

By contrast, nearly 50% said they would increase portfolio space dedicated to venture capital and growth funds — usually equity investments made in new and burgeoning companies. Only 8% said they would decrease their allocations to venture capital.

Again, many financial professionals think what is most needed is a better explanation of both the benefits and risks of private credit. Simon Tang, the head of U.S. limited partnership sales at the private investment firm Carta, noted that retail investors are relatively new to the world of private credit.

Understand private credit, other alts as long-term holdings

For decades, the primary lenders were large institutions like pension funds, endowments and foundations. Most of those large investors know that private credit is generally meant to be a long-term investment.

Now wealth managers have a responsibility to help retail investors come to the same understanding, Tang said.

“You have certain vehicles that allow you to redeem at intervals,” Tang said. “But, fundamentally, it’s still a long-term asset class. If you take that perspective, that’s really where you see the difference between retail investors and institutional investors.”

Tang said a long-term outlook will help clients understand now isn’t necessarily the time to make big changes with private credit — no matter what the headlines say.

“If you take the cyclical nature of this strategy or this asset class, and you couple that with the fact that it’s a long-term investment — maybe a fund that has a 10-year lifetime — you’ll understand that now is not the time to necessarily double down or to withdraw,” Tang said. “It’s more of a big-picture strategy that you need to have instead of flinching in either direction.”