Private credit stress provides new opportunities for secondary investors

Growing liquidity pressures in private credit funds are creating an opening for a new generation of secondary investors, which can provide managers with an alternative source of cash as investors seek to exit, according top a report by the Financial Times.

Private credit secondary funds can acquire stakes from investors looking to sell or purchase loans held by funds seeking to raise liquidity. The strategy is gaining relevance as both institutional and retail-oriented private credit vehicles face growing redemption demands.

Older institutional funds are increasingly under pressure to return capital to investors, while semi-liquid funds aimed at retail investors have faced elevated withdrawal requests. Concerns over exposure to software companies vulnerable to artificial intelligence disruption have added to the pressure.

The 10 largest credit funds recorded $1.8 billion in net outflows during the first quarter, according to Morningstar, although withdrawals were generally limited by the 5% of net asset value that semi-liquid funds typically allow investors to redeem each quarter.

If that level of outflows continues, managers may need to supplement income from loan portfolios, portfolio turnover and existing cash reserves with additional sources of liquidity.

That could create opportunities for secondary investors to work directly with fund managers rather than simply buying distressed assets from investors seeking an exit.

One potential structure would involve a fund selling a portfolio of loans to a special purpose vehicle backed by a secondary investor. Such an arrangement could provide the fund with additional cash while allowing it to retain management fees associated with the assets.

The terms could also provide secondary buyers with attractive economics. Even where assets are transferred at net asset value, buyers could potentially reduce their effective entry price by agreeing to defer payment.

The market remains relatively small compared with the broader private credit industry. Ares Management raised $7 billion for a private credit secondary fund from institutional investors earlier this year, while total assets managed by private credit secondary vehicles are estimated to be in the tens of billions of dollars, compared with more than $2 trillion across the wider private credit market.

The strategy could also appeal to semi-liquid funds that are not currently facing acute stress. Maintaining access to a secondary buyer could provide managers with an additional liquidity option if redemption requests increase.

However, the approach is still relatively new. Selling loans from semi-liquid funds could simply transfer credit risk from one investor base to another if concerns over the underlying assets prove justified.

Even so, the development gives private credit managers another tool for dealing with liquidity pressures as the asset class expands further into the retail market.