When various funding advisor and supervisor Cliffwater LLC launched its first personal credit score fund, Cliffwater Company Lending Fund (CCLFX), in June 2019, few folks within the wealth administration business had been listening to alternatives in personal credit score. Actually, few RIAs had been acquainted with both personal credit score investments, interval funds or Cliffwater LLC, based on firm CEO Stephen L. Nesbitt.
Whereas the preliminary buy-in from the RIA group was sluggish, the fund now has $20 billion in property. It delivered an annualized return of 9.45% since inception and a year-to-date return of 5.65% in 2024. What’s extra, personal credit score has emerged as one of many hottest various funding choices within the personal wealth channel, though with some caveats.
In 2021, Cliffwater added one other personal credit score fund to its portfolio, this time with a give attention to extra area of interest alternatives. Cliffwater Enhanced Lending Fund (CELFX) supplies asset-backed lending, specialty direct lending, regulatory capital aid, actual property mezzanine loans, enterprise lending and structured credit score, amongst different methods. Since July 2021, CELFX offered an annualized return of 13%. Its year-to-date return in 2024 reached almost 6%.
In February, the agency additionally took over as an advisor for a young supply fund launched by Mass Mutual subsidiary Barings in 2022. Cliffwater transformed the car into an interval fund and renamed it Cascade Personal Capital. The fund’s focus is on alternatives in personal fairness, personal credit score and different personal market investments, starting from buyouts to non-public debt.
WealthManagement.com lately spoke with Nesbitt about how the marketplace for alternate options within the personal wealth channel has advanced over the previous 5 years, how the agency connects with the RIA group and what RIAs ought to know concerning the dangers and alternatives of personal credit score investments.
The following has been edited for size, model and readability.
WealthManagement.com: What’s the profile of the corporate’s typical investor?
Stephen Nesbitt: We work with a little bit over 700 U.S.-domiciled registered funding advisors, who in flip present funding companies to their underlying particular person traders. We’ve three 40 Act funds. We market these to those RIAs, who in flip will put their particular person consumer cash into these funds.
WM: Cliffwater launched its first personal credit score interval fund in 2019. Are you able to discuss how the personal wealth marketplace for various investments might need modified from that point interval to at present?
SN: Initially, it was very sluggish. We’ve form of grown up with personal retail alternate options. The expansion in our fund is a mirror picture of the expansion and curiosity typically in personal alternate options. In 2019-2020, issues had been fairly sluggish. They began to choose up after that. Beginning in late 2021 up till the post-COVID interval, development has been pretty speedy for our funds. And there are another good choices on the market which have additionally grown considerably over this time interval. I actually consider we’re within the very early phases of using alternate options throughout the retail sector, and I count on continued development and extra choices by the funding business within the years forward.
{The marketplace} actually wasn’t acquainted with personal debt on the time. I wrote my first e-book on personal debt in 2019, Personal Debt: Alternatives in Company Direct Lending, to assist educate each the institutional and the retail market. Mainly, personal credit score and personal debt didn’t exist for most individuals. So, that was a hurdle—getting folks to grasp what they had been investing in. And secondly, we provided our product in an interval fund, they usually weren’t acquainted to retail traders or RIAs or actually anyone at the moment. That was the second hurdle we needed to recover from—educating them on the interval fund car. The third impediment 5 years in the past was figuring out who we had been. They knew who Blackstone was, they knew who Apollo was, they knew who BlackRock was, however no one knew Cliffwater. So, we needed to educate the RIA group on who we had been and that they may belief us to execute a non-public credit score car.
Right this moment, I feel we’ve overcome all three of these hurdles, and that’s why our development price has accelerated.
WM: How did you determine what sort of fund you had been going to make use of? What made you decide on an interval fund?
SN: There are a variety of causes. One is comfort. Our evaluation is that retail traders and RIAs, as a mirrored image of the retail investor, like comfort. They don’t like a variety of paperwork. Personal funds, even some BDCs, require an excessive amount of paperwork—and never solely paperwork, however capital calls, distributions. There may be a variety of complexity and investor qualification going into them. So, the primary issue is comfort. It’s simple. You spend money on a ticker, and also you make investments the following day.
The second purpose was liquidity. The interval fund, in contrast to the personal fund, in contrast to BDCs, supplies the best assurance of liquidity and most liquidity. You will get out underneath most eventualities as soon as 1 / 4 versus a non-public fund, the place it’s a must to wait 5 to seven years. A BDC says they may present 5% liquidity, however it’s contingent on the board of administrators saying “sure.” A BDC can put a gate down on any quarter. Interval funds can’t. So, in our thoughts, offering the investor with most liquidity was the second purpose we selected the interval funds.
The third purpose was we may appeal to the non-qualified investor. We may try this as a result of, like most interval funds, we don’t cost a efficiency charge. Consequently, anyone can spend money on our fund; it doesn’t require pre-qualification. That’s essential to RIAs as a result of they don’t actually wish to discriminate between their traders on who’s certified and who’s not certified.
The fourth purpose is the interval fund follows the 40 Act rule, which limits using leverage. And our feeling has at all times been that personal debt ought to be an alternative choice to investment-grade conventional fastened revenue, so the danger must be low. The leverage limits telegraph to our traders that the dangers on our funds shall be low, notably in comparison with personal funds and BDCs, which typically have over a full time period of leverage. Their volatility is way higher than the volatility of an interval fund.
I’d add yet another factor—transparency. As a 40 Act car, we’re required to reveal all of our holdings, all of our charges, all the things. You hear lots at present about governmental concern about transparency—is personal credit score a black field? Nicely, with our interval fund, it’s not. We’re regulated; we’re required to reveal all of our holdings.
WM: How do you join with the RIA viewers? And has that course of changed in any important method from the way you had been doing it 5 years in the past?
SN: We consider the RIA group has grow to be very institutional. You don’t promote to them; it’s a must to set up a partnership or long-term relationship with them, in contrast to the wires or a few of the banks, the place they’re simply making an attempt to receives a commission to promote one thing. RIAs are a unique ilk and extra institutional-like the place they set up a long-term relationship with their purchasers. We’ve to do the identical factor.
That meant we needed to construct a direct gross sales drive with Cliffwater workers, not a 3rd get together. Arguably, third-party advertising and marketing corporations are usually mercenaries, so as an alternative, we went the direct gross sales route and employed our personal salespeople. We employed very expert salespeople, who principally aren’t solely promoting a product however promoting the product throughout the context of an total portfolio. So, once we discuss to RIAs, we’re additionally speaking to them about total asset allocation, what’s occurring with not solely their conventional investments, however various investments, and we assist them and supply them with instruments to combine or allocate between personal alternate options and conventional investments. So, it’s extra of a high-touch sort relationship quite than a transactional relationship.
That is what’s distinctive about our strategy. With retail traders or RIAs, many of the merchandise on the market, whether or not it’s BlackRock, Blackstone, Apollo, KKR, all these guys are promoting their particular person platforms. These are good corporations, however they’re restricted. They need to originate their investments. So even when I do know who the perfect agency out there’s, why ought to I simply allocate to that finest agency? I gained’t find yourself being sufficiently diversified. It’s higher to speculate throughout a number of managers or personal fairness corporations to realize diversification.
If you happen to settle for that—and by the best way, a few of the largest pension funds on the earth find yourself investing in 25 to 50 managers—that may be a heavy elevate for particular person RIAs to have the employees and purchase the information to establish who the perfect are and allocate throughout a number of funds. That may be an administrative burden. So, folks rent Cliffwater or spend money on our funds not as a result of we originate loans however as a result of we will entry loans throughout a number of lenders which have relationships which are skilled. We are able to diversify to a a lot higher diploma, hopefully, know who the perfect lenders and managers are, and save the RIAs the time, angst, and administrative problem of doing that analysis themselves.
WM: So, is all outreach accomplished in-house or are there further channels that Cliffwater makes use of to attach with RIAs?
SN: That’s the one channel. On the funding aspect, we have now 41 folks devoted to researching lenders and funding corporations and executing loans with these managers. After which on the flip aspect, we have now 27 devoted salespeople targeted on relationship constructing with 700 RIAs. After which we even have about 26 admin folks, who do the block and tackling, the executive work in managing the portfolio.
WM: I perceive that the Cliffwater Enhanced Lending Fund, in contrast to your preliminary Cliffwater Company Lending Fund, focuses on higher-risk methods. Why is now a very good time to do this?
SN: We launched the Enhanced Lending Fund three years in the past, and we have now near $4 billion in that fund. After we have a look at personal debt, it’s like actual property—many individuals discuss core actual property and non-core actual property. It’s the identical factor with personal debt. Core is direct lending. It’s the most secure senior secured; it’s the largest a part of the market at over $1 trillion. And there are a variety of good managers who try this, and it’s nearly quasi-indexing personal lending. It’s a really environment friendly market. That’s our flagship fund, the CCFLX.
There are lots of extra bespoke personal debt methods that cowl smaller markets—plane finance, enterprise lending, different types of asset-backed lending, actual property debt, royalties. These are extra area of interest merchandise and area of interest markets that, in our opinion, to achieve success in them, it’s a must to decide the precise supervisor. It’s extra manager-driven, so we determined to place these extra non-core methods into one fund, which we name the Enhanced Lending Fund. And placing them collectively may be very handy as a result of the RIA doesn’t have to choose which technique to enter; they’ll diversify throughout methods. And secondly, a few of these enhanced lending methods may shut down every so often, or could also be overvalued every so often. So having the ability to shift to totally different sub-strategies inside enhanced lending may be very helpful for the investor.
WM: About two months in the past, we began listening to extra issues, akin to these raised by Jamie Dimon, about all these personal credit score funds and what’s going to occur if we have now one other lending disaster or downturn. What’s your outlook on dangers that may include personal credit score investments?
SN: I don’t assume most of those folks know what they’re speaking about. Jamie Dimon appears to be very good about business banking, however I query whether or not he’s educated about personal debt. In the end, direct lending is about making senior secured loans, offering the most secure financing to center market U.S. corporations, the core engine of the U.S. financial system.
The pricing for that ebbs and flows. When folks be ok with the financial system, spreads are available, or the yields aren’t as nice from the lender’s perspective. And when individuals are spooked concerning the financial system, or we enter a recession, these spreads widen. These actions in spreads are correlated to default charges. During the last a number of years default charges have been fairly low. Different instances, throughout a recession, defaults will improve. There’s a cyclicality on this market that hasn’t gone away and doubtless is not going to go away. No person, to my information, is ready to predict these cycles—Jamie Dimon or anyone else. So, what you attempt to do is construct a diversified portfolio that may handle its method by means of good instances and dangerous..
WM: Given the place we’re available in the market proper now, and if you happen to comply with the recommendation of remaining diversified while you spend money on personal credit score, what sorts of returns can traders count on to see?
SN: If you happen to learn a latest paper I wrote, “Direct Lending for the Lengthy Run,” I lay out what I feel the return ought to be. We predict short-term charges are going to return down. I feel our quantity for a standard direct lending portfolio was 10 to 12%. So, both excessive single digits or low double-digit returns. Our expectation is an 11% long-term common yield on direct lending, and it’ll ebb and move round that.
WM: We’ve seen fairly a variety of new funds launched lately specializing in personal credit score. How do you view your competitors within the personal credit score area?
SN: Competitors is nice; it’s what makes this nation nice. Competitors retains us on our toes. And fairly truthfully, we had been one of many first to be promoting to the RIA channel, and being alone in that effort wasn’t good. Folks questioned why there was only one providing. However now that different folks have jumped into the pool, folks really feel extra snug. “If Blackstone is doing this, if Carlyle is doing this, there should be one thing to it, so I’ll take Cliffwater extra severely.”
WM: Is there the rest that you just really feel is essential for RIAs to bear in mind about personal credit score investments?
SN: RIAs have struggled over the past decade looking for a secure funding that may have a fairly important yield or money move. It’s been a wrestle post-financial disaster. If you happen to have a look at conventional funding grade fastened revenue, it returned not way more than 2 to three%, with a variety of volatility. So it hasn’t actually match the invoice of security.
Folks tried hedge funds for some time, and whereas they’ve accomplished a little bit bit higher, in all probability 4 to five%, they’re very tax-inefficient and sophisticated. And there are only some that do very effectively. That’s been a wrestle.
Money yields till lately have been zero. Proper now, from my standpoint, RIAs have been given a short-term lifeline with increased short-term rates of interest. However it’s not going to final. It’s going to settle in on the inflation price, which appears to be like to be arguably 3%. That’s not going to chop it both.
So, actually, the one funding on the market that may present security and important yield and is investable is direct lending or personal debt. What you hand over is modest liquidity. As an alternative of having the ability to commerce it each day, like money, you may get in on any day for our fund, however you’ll be able to solely get out as soon as 1 / 4 underneath most eventualities.
When it comes to asset allocation that RIAs have a look at, it’s nearly a slam dunk that direct lending personal debt goes to develop as a p.c of portfolios. Proper now, we see that a few quarter to half of RIAs’ personal alts allocation is in personal credit score. And we expect that can proceed to develop as a fraction of personal alternate options. I feel the allocation to non-public alternate options itself will develop. It’ll take a number of years, however I feel it should begin to strategy 15 to twenty%.
