Business Breakdowns
· Josh Clarkson
[00:00:00] S1: These are really important points that matter for a lot of people, and definitely want to confront them head on. Taking a bit of a step back, it's important to bear in mind that individual investors have had access to many of these strategies, such as private credit, for quite a long time. Publicly listed BDCs have outperformed liquid benchmarks since the financial crisis. And you've had private semi-liquid alternatives available in the private wealth channel for five or six years now at real scale. And that's gone generally pretty well. Now, recently, coinciding with this greater move to expand the aperture of that retail base to get these into 401k plans, you've had a few idiosyncratic situations. An auto parts supplier named First Brands, a subprime auto lender named Tricolor are two of the biggest. There have been a few others that some commentators have positioned as private markets deals gone bad or canaries in the coal mine of private markets. However, what's really important to bear in mind is that neither of these companies were PE owned, and neither of them were primarily financed by private credit. They both primarily raised financing, especially at the corporate level, in the liquid markets. First Brands was a massive BSL issuer. In fact, when they went to refinance and there was potentially going to be some private credit involvement in the second lien, those were who were pushing for the quality of earnings, as well as other funds that were potentially going to be involved. It wasn't all private credit, but it was many private credit firms pushing for greater transparency and deeper diligence that brought the house of cards down, so to speak. While these are bad idiosyncratic situations that, according to a lot of the reporting, likely involve fraud, it's really important to understand that delineation between liquid and private markets and that just because these used a little more off-the-run financing structures or didn't issue regular way bonds, that doesn't make it a private markets issue.
· Josh Clarkson, Matt Reustle
And I'd say if anything, especially in the area of credit, this only makes the case stronger that to access sub-investment grade corporate credit and the high single digit, low double digit yields that can deliver for an income-seeking investor, direct lending and private credit is a far better, far safer way to do it than the liquid markets. [00:00:00] S0: It's a fair rebuttal. It points to the idea of the diligence that actually does go and happen with these firms, and they don't last for long if they're not doing some of that. Let's just step back and capture some of the dynamics with the regulation changes and what is happening. You mentioned this isn't a completely new phenomenon. There's been increasing access. Can you just provide some type of background backstory to how we've led up to this point?
· Josh Clarkson
[00:00:00] S1: Let's get out of the way the elephant in the room, if you will, of the most notable recent regulatory step, which is President Trump's executive order mandating that ERISA look into adding private markets into 401k and DC plans and facilitating that change. That was the big bang recently that really set a lot of this off, and that countermanded a Biden executive order that said they were probably not a fit because there had been attempts at this before. But the Trump executive order, which had been long anticipated, is certainly viewed as the largest, biggest change recently that opens a whole new market. Now, beyond that, there have been other more recent regulatory changes, such as no-action letters around marketing rules and some changes about how many illiquid assets certain types of funds, like interval funds and closed-end funds, can hold. I think some of those are more around the edges. But if you go back much further, the beginning of the United States securities regulation as we know it today was really in response to the Great Depression. And in the Great Depression and the run-up that preceded it in the '20s, you did have lots of these investment trusts that were leveraged investment vehicles investing in the hot stocks that performed very poorly. And so the SEC was very focused on regulating what types of commingled investment products could be brought to market for the retail market. And they created the world of registered securities, which means both individual securities as well as mutual funds. And over time, certain exemptions to that evolved: certain private markets exemptions, certain other type of structures.
· Matt Reustle
[00:00:00] S0: Yeah, and maybe you can elaborate on some of the products that did become available to retail investors and how some of those played out. Maybe they can instruct what's going to happen in the future.
· Josh Clarkson
[00:00:00] S1: Call it in the pre-2020 era, pre-2015 era, there were private markets available for retail in a variety of structures. There were certainly non-traded REITs that have been around for a while, not necessarily brought to market by top-tier operators, not necessarily with the most shareholder-friendly structures. There have been various ETFs that tried to mimic alternative asset management returns. There had also been reinsurers set up by some big-name hedge funds where the investment portion would be handled by that big-name hedge fund, and you were supposed to be able to get that exposure. Bill Ackman certainly has a well-known closed-end fund listed in Amsterdam. But these had all been relatively niche products. Where you really saw real momentum get behind this in the private wealth channel was when BREIT and BCRED were rolled out by Blackstone about five or six years ago now. And then many other top-tier alternative asset management firms have brought out similar products that are non-traded BDCs, non-traded REITs, and interval funds are the three main categories. That's kind of what turned on the modern semi-liquid wealth channel private markets experience, if you will. And generally, it's proceeded pretty well. Investors have enjoyed really strong returns, really strong downside protection. And when there have been issues, such as BREIT in 2022, the managers have stepped in to structure transactions like what they did with UC Regents to ensure that investors were able to get access to the liquidity that they were promised, which generally speaking is about 5% of NAV a quarter, can vary a little bit by fund. Investor education is a really important part of this. The alts managers are doing a great job of being very clear about this. They're sometimes dependent on that intermediary being clear about it. But I do think it's very important that the investors in these products acknowledge that they are essentially illiquid compared to an ETF that you could sell your entire position in in a minute and should think about that appropriately in their liquidity needs and their financial portfolio.
· Matt Reustle
[00:00:00] S0: Do you have a quick summary on BREIT of how that played out? And you don't have to get into the nitty-gritty details, but how it worked through the system and as an example of what happens when you have, in theory, illiquid security dealing with some type of issue around it and how investors are treated or what their options are in that type of situation.