As private capital markets surged in recent years, the ability for private credit and private equity assets to seep into exchange-traded funds appeared all but inevitable. Now, a few funds that arrived in the fall are challenging conventions in an ETF market that champions transparency and fair value.
The global private equity market, including venture capital, is estimated at about $6 trillion by S&P Global and has traditionally only been available to institutional investors and individual accredited investors.
The fast-growing private credit market is expected to top $3 trillion in assets under management by 2028, according to Moody’s Ratings, having only passed $1 trillion at the end of 2020. Spurred by tighter capital requirements and risk aversion at traditional lenders, asset managers stepped in to secure the balance sheets at middle-market companies and for larger buyouts.
Unlike syndicated loans, where the risk is spread among several banks, these loans are often made and held by individual private credit funds. Similar to syndicated loans, however, the assets can also be packaged into collateralized loan obligations for a broader swath of investors.
On Dec. 2, asset managers BondBloxx Invesment Management and Virtus Investment Partners separately launched ETFs holding only private credit CLOs. Syndicated loan CLO ETFs added assets throughout 2024, led by the $19.9 billion Janus Henderson AAA CLO ETF with $11.1 billion in net flows and a 0.21% net expense ratio, according ETFdb.com, a VettaFi database.
The $53.1 million BondBloxx Private Credit CLO ETF, subadvised by Macquarie Asset Management, gained $40.3 million in net new assets since its launch. Focused on investment-grade exposures, the fund has an expense ratio of 0.68%.
The $17.6 million Virtus Seix AAA Private Credit CLO ETF, managed by Seix Investment Advisors, added $7.5 million in net assets since its launch. Its expense ratio is 0.29%.
Tony Kelly, co-founder of BondBloxx, said the firm’s new ETF is garnering attention from institutional investors in private credit as well as financial advisers who are looking for a complementary holding to interval funds and other less liquid private credit vehicles.
“Having a daily, liquid ETF also adds more information to the pricing market and that benefits smaller investors,” Kelly said.
Further on the horizon is a potential offering from State Street Global Advisors, the SPDR SSGA Apollo IG Public & Private Credit ETF, first filed with the U.S. Securities and Exchange Commission in September.
Unlike the public and private CLO products, the SSGA/Apollo offering, as filed, would allow for a wider swath of private credit exposures through direct loans, packaged products, including CLOs, as well as private funds and closed-end investment companies, such as interval funds and business development companies. Both SSGA and Apollo Investment Management declined to comment on the filing.
Challenges for ETFs
Moving from structured vehicles such as CLOs, which are well served by the asset pricing and credit rating markets, to direct investments and fund stakes poses several challenges for ETFs.
Technically, ETFs, governed by the Investment Company Act of 1940, can hold up to 15% in illiquid assets. Often, ETFs that feature less liquid securities and exposures tend to create and redeem shares in cash — leaving it up to the asset manager to source or dispose of assets.
ETF liquidity and transparency, on the other hand, is improved when market makers can exchange underlying assets and fund shares in kind — helping to keep the ETF's market price in line with its net asset value.
Illiquid securities can be harder or more expensive for traders to hedge in the derivatives market. Less certainty in underlying asset pricing can also compel wider trading spreads.
Within private equity, some ’40 Act funds have, in the past, participated in funding or acquiring shares of late-stage growth offerings. Most prominently, shares of Meta (formerly Facebook) and Uber Technologies were available in several mutual funds prior to those companies’ initial public offerings.
These funds were unfettered by the constraints of publishing intraday net asset values and end-of-day holdings, critical information for ETF investors and traders to ensure that their shares were fairly priced — or within a reasonable range of premium or discount to NAV.
On Dec. 3, the ERShares Crossover ETF (XOVR) from EntrepreneurShares disclosed a $10 million investment in privately held SpaceX, growing to $33 million as of Jan. 31, or 10.8% of the $307 million ETF. The fund also holds a $2 million investment in Klarna.
These holdings mark the first time that prominent nonpublic company equity exposures have been available in an ETF. Investors have rushed in, adding $178 million in net new assets to the ETF since early December, even as the private company prices disclosed by ERShares have not moved.
The remaining assets in the ETF are publicly traded stocks tracking the Entrepreneur 30 Total Return index. These stocks flow in to (or out of) the fund through in-kind creations or redemptions. The fund only accepts (or redeems) cash in lieu of the private exposures.
“We have implemented rigorous mechanisms to carefully manage our private company exposures,” said Joel Shulman, founder, CEO and CIO of ERShares, adding that "the fund adheres to a disciplined approach, ensuring strict compliance with the 15% threshold while maintaining a well-balanced and diversified portfolio to protect investor interests."
A handful of mutual funds continue to own high-flying private companies, including SpaceX, while closed-end fund Destiny Tech 100, aspiring to hold the top 100 private growth companies, trades at nearly a 900% premium to its underlying net asset value, according to Morningstar, serving as a cautionary tale for the ETF market.
The question of daily valuations for private equity securities is unsettled, even as a handful of private market exchanges offer transactions and prices on unlisted stocks. Still, it appears more likely that growth equity companies with greater than $1 billion valuations — unicorns, decacorns, hectocorns, etc. — could inch further into the mutual fund or ETF market before traditional buyout exposures, which tend to have control owners and limited common equity available prior to a sale.
For example, Morningstar now publishes the PitchBook Unicorn 30 index, tracking the largest growth-equity exposures in the private market. Using a combination of PitchBook data on recent funding rounds and secondary market trading, the equal-weighted index joins other providers such as Lagniappe Labs/Level ETF Ventures and OpenVC trying to track, and potentially financialize, exposure to growth equity.
“The arc of innovation is moving toward retail exposure,” said Sanjay Arya, senior vice president and head of innovation, index products, at Morningstar. “In the last 10 years, venture-backed private markets have moved to about 9% of all equity market value.”
Most analysts, however, agree that illiquid assets and fund stakes traditionally held by venture capital and private equity funds are a challenge to fit within the current expectations for daily liquidity and transparency expectations in the ETF market.
“It’s technically possible, but important to understand the impact of the liquidity mismatch between the underlying securities and the ETF wrapper,” said Aaron Filbeck, managing director, global content strategy, for the Chartered Alternative Investment Analyst Association.
“ETF issuers want to democratize access to everything for everyone, but there are benefits to investor protection and regulations, particularly around risk and the wide dispersion of outcomes in private markets,” Filbeck said.
