Transparency key as advisers delve into private markets

With the astonishing skew to “what is working well,” reading monthly fund reports one would expect equally astonishing alpha. Clearly, that is not the case, and investors are largely left with cursory comments on the less-than-useful positions in the portfolio. At least in listed markets the attribution can be verified, assuming the fund is forthcoming in its full list of holdings. For all their  many faults, equity markets have a high degree of visibility.

Not so in private investment strategies. Renaissance Technologies, famed for the extraordinary performance of the closed Medallion fund, is in the news with an exodus of investors from the newer external funds. The reluctance to provide any detail on what was happening beneath the hood was another standout feature as performance badly flagged. It also highlights the problems with adding process-similar, but different strategies within a team – big-cap manager diversifies into small-cap, duration fund adds short-term income fund, and the like.

A notable feature of most recent private credit strategies is the lightweight level of information; there’s maybe a pie chart on industry exposure, some data on maturities and yield, but often not much more. Credit quality often relies on a heavy dose of self-reporting assessment. What is totally absent is any comment on lending positions that are not performing quite so well.

Not all mortgage pools are similar. Some RMBS experienced a far larger proportion of repayment holidays than others in 2020. Yet “nothing to see here” was the common response. Into 2021, that might all be history and the end result may be the same, but there was almost no discussion of any distress at any time.

When there is the inevitable poor outcome, one can wonder if and how that will be disclosed. The apparently untainted private lending sector creates a dilemma. If any fund now outs itself with problem loans, investors are likely to react with aversion rather than welcome the transparency.

Unless basic investment dogma is wrong, higher yields should be associated with higher risk. By the same token, spreads have narrowed and competition has reduced the margin on private credit. Yet it can be hard to get a fund manager to acknowledge the potential lower returns now on offer or the reality that to maintain yields, higher-risk positions have to be included.

This may often be the rationale to introduce a new higher-yield strategy from a successful low-risk base run by the same team. The brain switch required in considering one debt deal too risky to where it is eminently suitable for another fund is unusual for the traditionally conservative slant of fixed income. Imagine an equity house judging a stock too highly valued for one fund, but worth inclusion in another.

The newness of private credit in its investor-friendly format has been enthusiastically embraced by most advisery groups. It surely, though, is not a free lunch, with no apparent volatility or loss risk. An improved depth of understanding of mortgage pools and private credit intermediaries would not go astray. Transparency should enhance trust rather than cause uncertainty.

Giselle Roux

Giselle Roux is one of Australia's most well-known and highly regarded investment strategists, having held the role of Chief Investment Officer at both Escala Partners and JB Were. She has also held a number of senior equities analyst and investment banking roles including with Citigroup, Bank of America Merrill Lynch and McIntosh Securities. Giselle is a host of Inside Network events, a member of the Advisory Committee and regular contributor to the Inside Adviser and Investor publications.