In recent weeks, the Financial Times has published several articles offering very different perspectives on the growth of private assets and private credit: the latter, in particular, has been the subject of reporting and analysis following the well-known episodes of “illiquidity” (suspension of repayments) that affected prestigious investment firms such as Blue Owl and Blackstone, as well as the stance taken by leading U.S. banks regarding the reduction of leverage provided by private loans (which some banks have written down). Everything related to “private” is undoubtedly the subject of ongoing—and often critical—debate regarding this important segment of the financial markets.
On the one hand, private credit is presented as an essential component of the financial system. Following the 2008 crisis and during the pandemic, this type of financing helped fill the void left by banks, which are increasingly constrained by regulatory requirements. Today, it finances many middle-market companies—firms that employ tens of millions of people and often lack access to public bond markets. According to this view, private credit supports employment, investment, and economic growth, offering a source of capital that complements the traditional banking system. We have already discussed this sector in several of our recent Insights. However, here we wish to offer a slightly different perspective to justify, at least in part, our cautious stance—one that steers clear of both “crying wolf” too soon and too easily about a bubble risk (which many analysts believe is about to burst) and denying that the sector faces a problematic situation; one that has, at best, entered a phase of stress.
The private credit profile is more conservative than many critics acknowledge. Business development companies (BDCs), designed to offer retail investors access to private credit, typically have a leverage ratio about two times (or even less) lower than that of large banks (even though much of the banks’ debt comes from deposits).
These funds do not rely on federal deposit insurance or the Federal Reserve’s discount window (short-term loans to commercial banks short on cash). This means that losses are largely absorbed by sophisticated institutional investors who understand the long-term risk profiles, rather than creating exposure for taxpayers. Furthermore, much of private credit is structured in funds with locked-in capital and is not financed by bank deposits that are repayable “on demand”; consequently, it is less exposed to a “bank run” in the traditional sense as we understand it for the banking system. BDCs include built-in mechanisms that regulate the handling of redemption requests when they exceed certain thresholds—precisely the kind of structural safeguards that prevent disorderly liquidations. In neither case does the underlying risk transfer to the broader financial system in the way it does with bank failures. From this perspective, the suspension of redemptions by many large funds—which is entirely legitimate—far from being a problem, would prove to be an appropriate way to manage a stressful situation.
When a sudden macroeconomic panic occurs, the price of listed stocks or debt can plummet rapidly if investors begin to sell. Since many private credit funds are long-term and not publicly listed, companies and portfolios are shielded from the sentiment-driven volatility of public markets. In reality, this is a contentious point because critics argue that this is a mechanism to conceal a significant dimension of risk (the so-called market risk that gives rise to one of the most relevant risk metrics: volatility).
In this Insight, however, we wish to discuss the “private assets” investment class more generally, with a particular focus on the European market, which is decidedly more nascent and less developed than its transatlantic counterpart but is laying the groundwork for significant growth driven in part by retail investors. It is called the “democratization of investing” because it aims to spread investment opportunities as widely as possible by making them available to everyone: however—in our humble opinion—this phenomenon risks becoming the real problem for these asset classes, which are by definition illiquid and therefore—according to the philosophy guiding European lawmakers and regulators on financial matters—incompatible with the retail investor market. When we factor in their inherent complexity, we believe our skepticism is more than justified.
On the other hand, there is growing debate in Europe about opening up private markets to retail investors. New vehicles such as ELTIFs (European, especially version 2.0) and LTAFs (British) have been designed to allow individual savers to access private equity, private credit, and infrastructure investments. The goal is to channel savings into the real economy and expand return opportunities.
However, several significant concerns are emerging:
• limited liquidity of the underlying assets
• less frequent valuations, which can mask volatility
• higher fees compared to traditional funds
• risk of mis-selling if retail investors do not fully understand the products
In summary, the debate is not so much about the usefulness of private markets—which is now widely recognized—as it is about how to expand them responsibly.
The real challenge for the sector will be to strike a balance between three elements:
1) broader access to investments;
2) investor protection;
3) efficient financing of the real economy.
This issue is set to become increasingly central as private markets and wealth management converge in the coming years.
We would go so far as to say that retail investors are not actually well-regarded by professional investors, primarily for at least two valid reasons. First, because qualified investors demand high-quality private investments, which could be compromised by the fact that funds designed for retail investors may receive substantial capital inflows that force them to invest in lower-quality assets. From an institutional investor’s perspective, private assets are a “scarce commodity” and, as such, valuable: it is therefore normal for a sophisticated investor to expect to maximize their investment through full allocation to these precious assets. Second, the liquidity needs characteristic of retail investors—which are decidedly incompatible with private assets—encourage a rush for redemptions in times of stress, which is detrimental to the assets that remain invested in the funds.
With these few lines, we hope to have contributed to a more balanced assessment of what is happening in the illiquid assets market, bearing in mind that we remain firm believers in the fact that bubbles burst when debts cannot be repaid somewhere in the economy, triggering a domino effect. The suspension of private debt redemptions does not constitute insolvency on the part of the funds that implemented it: it is a natural and necessary response for illiquid assets. The contagion mechanism, however, should concern us because even though banks are not directly involved, they have nonetheless provided leverage to this market, remaining entangled in a cycle that could prove vicious.
Disclaimer
This post reflects the personal opinions of the Custodia Wealth Management staff who authored it. It does not constitute investment advice or recommendations, nor does it constitute personalized consulting, and should not be considered an invitation to engage in transactions involving financial instruments.
