There have been several recently launched ETF products, seeking to provide investors with private credit exposure in a liquid ETF wrapper. These include new products combining public and private credit instruments that cap illiquid assets at 15%. However, the pricing of the illiquid portion of the portfolio remains a sticking point for regulators. There are also more traditional approaches that provide exposure to liquid private credit instruments such as Collateralized Loan Obligations (CLOs). 

But why are investors clamoring to get private credit exposure in the first place? Private credit offers attractive yields from an alternative asset class that is less correlated with equities and bonds. This diversification benefit can reduce portfolio volatility and improve risk-adjusted results. 

The rise of private credit

It used to be that companies in need of debt financing would go to their community bank and apply for a commercial loan or line of credit. But, that paradigm shifted after the global financial crisis (GFC). Sweeping regulatory reforms applied after the crisis resulted in banks being unable to take on as much balance sheet risk. As a result, private credit solutions outside the traditional banking system emerged to fill this financing gap. Private credit loans can be tailored to meet borrower needs in size, type, and term. Similar to bank loans, most private credit loans are floating-rate debt, moving directionally with interest rates. 

The private credit sector includes four main types of private credit instruments:

1. Direct lending – Non-bank lenders provide credit to private, non-investment-grade companies as part of the senior debt capital structure.
2. Mezzanine, second lien debt, and preferred equity - These loans are collectively viewed as “junior debt,” providing borrowers with subordinated debt not secured by assets. It ranks below senior debt and often comes with equity “kickers,” which are additional incentives that can help supplement returns.
3. Distressed debt - When companies are in financial distress, they work with existing creditors to improve their prospects by implementing operational changes and restructuring their balance sheets. Distressed debt is highly specialized; the abundance of opportunities tends to coincide with periods of economic stress and credit tightness. Lenders are willing to take on higher levels of risk in exchange for the potential for future higher returns.
4. Special situations - Special situations refer to non-traditional corporate events that require custom and complex lending solutions such as M&A transactions, divestitures or spinoffs, or other situations driving borrowing needs.

VettaFi’s private credit index 

VettaFi’s Private Credit Index (VPCIX) uses publicly-traded, liquid instruments to provide exposure to private credit through Business Development Companies (BDCs) and Closed-End Funds (CEFs) that primarily invest in the private credit sector. Through our composite index of closed-end funds, we identify CEFs and BDCs with significant private loan participation and CLO exposures. Our diversified index approach, consisting of 50-60 holdings, helps mitigate individual credit risk. In addition, the underlying funds are actively managed by some of the best private credit investment firms in the industry such as KKR, Ares Capital, and Blackstone. 

Attractive alternative income opportunity

The VettaFi’s Private Credit Index (VPCIX) construction methodology considers volatility and dividend yield adjusted by float-weighted market capitalization. This index approach overweights funds consistently rewarding investors with high dividend income. The dividend yield of the index is currently over 12%. 

If you would like to learn more about VettaFi’s new VettaFi’s Private Credit Index (VPCIX), please reach out using the form here.