April 1, 2025

How Has Private Credit Affected Valuations Across Debt Markets?

Investors can access a more diversified menu of credit investments, but due diligence is key—especially in thinly traded markets.

Reported by Bailey McCann

Art by James Yang

Institutional investors have more options than ever before when it comes to opportunistic credit investing. New funds regularly come to market offering access to illiquid parts of the credit universe in structures that claim to offer better liquidity terms and the potential for risk mitigation. Sources say this trend can make it easier for asset owners to diversify their credit portfolios but warn that due diligence remains important—especially in thinly traded markets.

Risk and Opportunity in Cat Bonds

So-called catastrophe bonds are one of those markets. Cat bonds emerged following Hurricane Andrew in 1992. At the time, Andrew, which caused $27 billion in damages, was the costliest hurricane ever to make landfall in the United States. Storm-related claims led to the failure of eight insurance companies and put others in deep distress. Insurers then raised premiums in U.S. coastal markets, coastal states created insurer-of-last-resort programs to help with payouts during major natural disasters, and insurance companies changed how they approached reinsurance to include cat bonds.

The first cat bonds started trading in 1997. The market has since grown to $50 billion in new issuance. That figure is expected to steadily increase as the cost and frequency of major climate-related disasters increases. Insurers will need to add reinsurance to ensure they remain solvent.

Cat bonds are designed to pay out when a specified risk happens and offer a risk premia based on duration, risk and investment size. Investors might invest in bonds tied to hurricanes in Florida, fires in California or earthquakes in Japan. These are typically shorter-duration bonds—about three years—and are floating rate, so returns are generally higher than more traditional parts of the market like Treasurys or high-yield corporate bonds.

For a long time, investors in this market were primarily other insurers, hedge funds and asset owners. Swedish pensions AP2 and AP3 have allocations to cat bonds, as do the Canada Pension Plan Investment Board, the Indiana Public Retirement System and the Maryland State Retirement and Pension System, among others. But that is beginning to change. Now, alongside hedge funds, there are UCITS [Undertakings for Collective Investment in Transferable Securities] funds, mutual funds and, as of this month, an exchange-traded fund, all offering exposure with more liquidity than might be available through a private insurance-linked-securities fund.

Brookmont Capital Management LLC April 1 launched the Brookmont Catastrophic Bond ETF, ticker symbol ILS. The fund is backed by a team that includes former Highland Capital Management cat bond investor Ethan Powell and the former ILS team from PIMCO. Powell says the way investors think about ETFs has changed.

“When you look at new ETFs, something like 70% of [those] launched last year were actively managed,” Powell says. “We think everyone understands that ETFs aren’t just low-cost beta plays anymore; it’s a lower-cost investment vehicle for a variety of strategies.”

According to the Securities and Exchange Commission filing for ILS, the fund invests in catastrophe bonds across a varied group of available perils and geographic regions (for example: Florida hurricanes, California earthquakes, Japan typhoons, Europe windstorms and Europe earthquakes). Alongside these bonds, the fund could invest in other insurance-linked securities, including quota share notes, excess of loss notes and industry loss warranties. The SEC limits how many illiquid securities can be in a fund, so ILS may also invest in liquid corporate bonds, cash or other liquid bonds.

“We view this strategy as an actively managed credit diversifier,” Powell says. “We aren’t getting into privately traded cat bonds or loss warrants or anything esoteric. Our bond impairment rate is below 3% per year. You can compare that to high-yield bonds which have a historical default rate of 3.5% per year.”

Powell adds that because cat bonds are floating-rate instruments, investors are somewhat protected from interest-rate uncertainty, as floating-rate securities typically have a higher yield and perform better in a volatile environment. The ETF structure allows for investors to sell out of their positions without running into lockups common to private funds.

Chin Liu, director of insurance-linked securities and a portfolio manager at Amundi U.S., which offers a cat bond mutual fund through its Pioneer Investments range, says that even in parts of the market with greater liquidity, it is still important to understand how cat bonds trade and avoid common pitfalls.

“There is a strong temptation for investors to sell into a disaster, and when you do that, you end up missing all of the upside of this investment,” he explains. “If a hurricane happens, the investment recovers after, when the premiums increase and the reinsurance does its job. Investors have to wait for that to play out.”

At Franklin Templeton Investment Solutions, which offers access to cat bonds through a UCITS fund structure, Robert Christian, a senior vice president and head of absolute return portfolio management, agrees. He says that trying to time the market for these investments can be especially difficult. Investors could have exposure to bonds for a hurricane in Tampa, Florida, see a bad weather report, try to sell and miss out in two ways. First, the hurricane could change course. Second, even if it does not change course, there is no bid/ask spread for the Tampa bonds, because the event is imminent.

“It’s not just that, ‘There’s no trade; call us tomorrow,’” Christian says. “It might be, ‘Call us in a week or a month or two months.’”

Because of this dynamic, the best audience, even for the ETFs, might be institutional investors or high-net-worth investors that are less likely to panic sell. Kirsten Chang, a senior industry analyst at VettaFi, says ETF strategies like this and other actively managed credit funds are part of a growing trend to provide strategy sophistication but at a lower total cost.

“What we’re seeing is that if you can invest in it, investors are probably going to want it in an ETF if it can fit, or at least [in] the lowest-cost structure available,” Chang says.

If not ETFs, asset managers are finding ways to get alternative credit into other lower-cost structures, including interval funds and separately managed accounts, alongside traditional commingled vehicles, mutual funds, evergreen funds and UCITS structures.

The net result, Chang says, is that, over time, investors could have portfolios that, from a strategy perspective, are as sophisticated as they have ever been in terms of mixing active and passive strategies, but the strategies are in vehicles that have lower total cost and limited lockups.

Lower-Cost Private Credit

Bill Smalley, the executive managing director of Bill Smalley, agrees. He says investors are looking for new asset classes and strategies to invest in. Virtus offers private credit exposure through the Virtus Seix AAA Private Credit CLO ETF, ticker symbol PCLO. Smalley says Virtus is looking closely at private credit and other parts of the actively managed credit universe for strategies that might work well within the ETF structure.

George Goudelias, CIO of the leveraged finance platform at Seix Investment Advisors, the subadvisor for PCLO, says that a big part of demand for the fund has come from institutional investors that want to add liquidity to their private credit portfolio.

“We don’t think this fund can replace traditional private credit exposure,” he says. “But if you have a traditional private credit exposure, you could use ETFs as a complement to offer some liquidity as needed.”

That’s the basic thesis behind a growing group of private credit ETFs that include BondBloxx Private Credit CLO ETF (ticker PCMM) and SPDR® SSGA IG Public & Private Credit ETF (ticker PRIV), which have launched alongside PCLO, and a recently launched private credit evergreen fund from Axa Investment Management Alts. Tony Kelly, co-founder of BondBloxx, says these new funds are responding to growing demand from the adviser community for ways to provide access to private credit suitable for both accredited and non-accredited clients.

“There is growing investor demand for access to private credit,” he says. “Investors want diversification, especially in an environment where there is uncertainty around more traditional fixed income like Treasurys.”

However, as with the new cat bond funds, Francis Griffin, a senior vice president in Callan’s alternatives consulting group, says it is important for investors of all types to take a look at what is actually in these funds.

“The SEC caps illiquid exposure in ETFs at 15%,” he says. “Just because something is called ‘private credit,’ the exposure might actually be much more correlated to Treasurys or other parts of credit that are liquid.”

Griffin says for investors looking at these ETFs, the due diligence process should be similar to that of a private fund. He says investors should understand the components of fund yield, including base rate spreads and fees, as well as portfolio concentrations. Getting a daily, real-time update on the value of less-liquid parts of the credit markets can also be challenging.

He adds that investors with experience trading listed business development companies have often seen volatility in that part of the market carry over to their portfolios. Non-traded BDCs, for example, can do a monthly valuation of their books, but likely could not provide daily net asset value, as ETF investors would expect.

ETFs that focus on collateralized loan obligations might run into similar issues, depending on how many borrowers are in the underlying assets and how liquid the underlying loans are. Griffin says investors should still have a granular analysis of what is actually in the fund.

“People are using CLO equity as a proxy for private credit, but CLO equity by itself is a relatively thinly traded asset class. It’s still possible to get whipsawed,” Griffin says. “You could be at the whims of market technicals and not just the fundamental value of a portfolio.”

Funds that are more liquid, or available to a wider variety of investors, are likely to be popular due to the increasing investor demand for access to private credit, Griffin says. But, he adds, whenever something gets popular, it becomes more important to think through investment goals and which structures make the most sense.

Putting thinly traded bonds into an ETF might mitigate some of the risk or provide access with easier exit terms, but these parts of the market are still going to behave differently and with potentially higher volatility than, say, U.S. Treasurys. Griffin adds that when you begin to democratize access to less liquid parts of the credit market—which is what ETFs and other accessible fund structures tend to do—it can have an impact on how those securities trade. “It makes valuation more complex; the asset can become more volatile,” Griffin says. The higher rates of participation in these markets become a market force.

“A lot of these products are being sold based on performance and the speed of return that they can generate,” Griffin says. “They are not necessarily being sold on the downside protective measures that are there, which is fine in a relatively benign environment. But what happens if clients look for a stable [net asset value] or truly reflective NAV or performance in a down market? Are liquidity measures going to hold up in the face of redemptions? I think those questions are not being as fully diligenced as they otherwise might be.”