Apollo partners with State Street Global Advisors for ultimate moonshot -- making alts liquid with ETFs -- but Apollo may make liquidity function at a premium untenable for investors, never mind the SEC

Apollo Global Management has announced a plan to sell private credit through ETFs, but the proposal looks to skeptics like a heads-I-win-tails-you-lose proposition.

The New York City private asset manager has partnered with State Street Global Advisors (SSGA) to create the ETF and present it to the Securities and Exchange Commission (SEC). 

Wall Street believes private credit is a way to get higher yields without more risk.

“We believe, in exchange for less liquidity, direct lending offers investors 250 basis points of yield, per annum, above leveraged loans,” writes J.P. Morgan.

Better yet, those premium yields in the $1.7 trillion private credit market don't necessarily raise the risk profile for an investor, according to Goldman Sachs Asset Management.

But Brian Moriarity, Morningstar associate director, fixed-income strategies, and Ryan Jackson, a manager research analyst, passive strategies, expressed some concerns that Apollo wears too many hats.

"Apollo appears to be the valuation provider, originator, buyer, and seller of the fund’s private credit investments, which may constitute the bulk of this ETF’s portfolio," they noted. 

“[SSGA] is relying on Apollo, not only to sell private credit instruments to the fund but also to … [enable] these normally illiquid investments to meet the SEC’s definition of liquid holdings.

"[But] swaths of the portfolio deemed liquid could become illiquid if Apollo fails to provide the bids,” they add.

Details scarce

SSGA declined to comment on the proposed investment, known as the SPDR SSGA Apollo IG Public & Private Credit ETF, citing “a quiet period” as its filings await SEC review. Apollo did not respond to a request for comment.

As such, details are scarce. What is known from filings is that the ETF would be the first to actively manage a mixed portfolio of public and private credit and a statutorily limited 15% stake in private, closed-end, interval, and business development funds.

Though the SSGA ETF wrapper provides the surface liquidity, Apollo – already one of a handful of secondary market players for private credit – is guaranteeing it can provide all the necessary liquidity for the private credit it supplies. 

Yet just how much Apollo will extract from investors to provide liquidity of last resort – or whether it will even be possible – is the rub for virtually every observer.

Undermining independence

“In practice, Apollo may determine the assets’ values that it purchases. In times of market turmoil or reduced liquidity, Apollo would have an incentive to offer lower bids to re-purchase assets at a discount,” says Micah Hauptman, director of investor protection at the Consumer Federation of America, in a public letter.

“The fund would then be in a difficult position of deciding whether to accept those bids in order to ensure sufficient liquidity or reject them and potentially fail to meet their redemption obligations. 

"This process would undermine the independent valuation process.”

Nothing in the current proposed fund structure would hinder Apollo from moving low-quality funds – at premium prices – from its private funds into the mooted ETF, says Brian Shapiro, founder of Manchester, Vt. alts aggregator and performance reporter Altsmark, via email.

“The SEC and everyone should be concerned that lack of transparency leads to Apollo selling the junk from its main private funds to the ETF at prices it wouldn’t normally get from a third party,” he says.

Indeed, without a standard means of pricing assets or obtaining pricing data, the SEC may not need to agonize over approval, says Moriarity.

“Investors need to have an opinion on the value of the ETF's portfolio … [but alts are] priced infrequently and very difficult to trade," he explained during the analyst call.

“If the data needs aren't met and transparency needs aren't met, then I don't think [this] convergence has legs.

Cataclysmic

The fact that Apollo’s commitment to buy back the fund's assets from retail investors is not absolute “raises red flags,” says Hauptman. 

“There can be no assurance that a trading market will exist at any time ... [and a private agreement between SSGA and Apollo] does not transform inherently illiquid assets into liquid assets," he explains.

“If one party to the agreement is unable or unwilling to live up to their end of the bargain, the assets that were subjectively agreed to be liquid may immediately become objectively illiquid,” he adds.

“It could be a cataclysmic change," says Philip Waxelbaum, principal of Masada Consulting, in an email exchange.

Of course, the SEC take is just the beginning of risk exposure. “Litigation risk for this … will make in-house counsel's and compliance gurus' heads spin. 

"The record-keeping and regulatory challenges would send the weak-spirited packing," he adds.

At the same time, Waxelbaum says the opportunity is epic.

Potential high returns

In theory, an alts ETF can spice up returns by investing up to a 15% allocation in what are essentially loans made by hedge fund managers. 

“Private credit offers the potential for higher returns, while generally not being inherently riskier than syndicated loans and high-yield bonds—as evidenced by comparable historical credit losses,” Goldman wrote in a July 30 article, titled “Public and Private Credit: Capitalizing on Coexistence”

No doubt jacking up spreads on fixed income would be a gobsmacking leap, according to Moriarity.

“It’s a groundbreaking shift,” he said in a mid-September call attended by analysts and the media.

Retail investors and RIAs would benefit from a vastly increased number of securities to invest in, given a global decline in listed and traded investable assets*.

Private fund managers would also get a big boost to their supply of capital.

Investor appetite

Alts shops are looking to diversify their capital pool into the high-net-worth market, Nizhar Tarthuni, senior analyst for Morningstar-owned alts data shop, Pitchbook, said during the call.

"There's a convergence of products [through] the democratization of access … [so] there's an appetite,” he said. 

With different channels than you have historically, like high-net-worth investors, you have to create wrappers to make them comfortable, he explains.

If the ETF were to become a class, it would be like strapping a rocket to the alts industry, says Waxelbaum.

“Not long ago, the biggest challenge was funds closed to new investment, because sponsors could not deploy [capital] quickly enough. Now there are deployment opportunities that need funding,” he explains.

“We have not had parity in supply and demand for alts in decades,” he says.

Why now?

Indeed, supply and demand are the catalysts for the launch of the SSGA-Apollo fund, says Moriarity, via email.

“The demand for making privates available to the broader public has been growing, rightly or wrongly. 

"And private credit - almost all of which pays a floating coupon - has performed relatively well in a recent period when investors might be unhappy with their fixed income allocation,” he explains.

"'Why now' is that it's a natural culmination of both the demand for private assets and the ascendancy of ETFs. 

"Many investors and advisors these days exclusively invest through ETFs, so this is meeting investors where they are.

“State Street’s benefit is, in short, fee revenue ... sure to exceed the average taxable-bond ETF’s 0.31% fee," he adds, in the article co-written by Jackson.

"If mainstream investors embrace the private credit ETF, SSGA could reap a healthy stream of recurring revenue,” the two analysts state.

Push and pull

If approved, the fund will also give Apollo a potentially huge distribution channel and a means to repackage poorly performing assets with performing assets to negate losses, says Shapiro. 

"They’ll be in a perfect position to push and pull performing and non-performing assets in between entities. [It will] create liquidity for their assets ... [and] a mechanism to buy assets at a discount on their own balance sheet.

“[But it’s] very risky for Apollo, too, exposing their balance sheet ... [and] the headline risk of poor performance."

Partners needed

SEC approval may require Apollo to partner up with other private fund managers* to diversify the fund's liquidity backstop, rather than go it alone, as it presently intends, says Waxelbaum.

“Sure, it will be 'best efforts' liquidity to make sure in all predictable scenarios there cannot be a run on the fund. [But] partner funds with Apollo as lead manager would be ideal and give regulators comfort.”

Broadening the number of backstop buyers is only one of the areas in which the SEC may demand third-party involvement, according to Jackson and Moriarity.

“Widely held securities are easier to trade because public disclosures and third-party ratings are more common, and buyers and sellers are more familiar with them, making it easier to quickly agree on prices … Private credit often lacks such familiarity,” they write.

“Private credit managers [also] typically rely on third-party firms to value their investments, given that they rarely trade … [and] it’s not yet clear if this ETF will use a third party," they conclude.

“Is the SEC comfortable with the idea that Apollo is the originator, provider of prices, seller, and buyer of these assets? They might want State Street to involve a third-party pricing service,” adds Moriarity, via email.

Winners, losers

If the SEC approves the SSGA-Apollo ETF, there are likely to be two major losers, namely managers of expensive feeder or interval funds, and alts marketplace vendors, according to Waxelbaum.

“If proof of concept allows for more ETFs with different investment objectives, it will present a serious challenge,” he explains.

“Feeders [and] facilitators are relatively expensive, [and] ETFs should be very adept at undercutting costs to investors."

Yet Frank Burke, chief investment officer of smaller alts and feeder fund marketplace PPB Capital Partners rejects the argument the new SSGA-Apollo ETF posed a threat.

“One of the key benefits of private investing is that long-term investors aren’t impacted by panic trades from other fund investors during times of stress. Offering private credit exposure in this type of publicly traded format neutralizes that benefit,” he explains.

iCapital and CAIS, two of the largest alts marketplaces declined to comment. 

Blackstone, KKR, Apollo, and Brookfield are four of the largest US feeder fund managers.

Filling a gap

Waxelbaum's assertion that the proposed Apollo-SSGA ETF could hurt alts marketplaces drew short shrift from Morningstar analysts. 

"The market iCapital serves might not overlap perfectly with the people who invest in ETFs. iCapital might offer better service, a more tailored experience, and access to assets or strategies that still might not make it into an ETF, assuming the SSGA-Apollo ETF is approved," Moriarity explains, via email.

“There's also the dynamic in which iCapital clients might expect access to the best ideas, [or] managers, whereas ETF investors are just interested in access to a market beta to fill an allocation gap.”

Yet the ETF model could prove a threat, albeit solely on the grounds of price, says Shapiro.

“This won't have too much impact on the private credit being sold through distribution channels as this may just scale for the lower end of the retail market … [but marketplaces'] biggest risk is their cost,” he explains.

“We already see it with CAIS slashing its fees. The appetite for 350 basis point expense ratio product[s] is vanishing fast.” See: CAIS memo about fee cuts raises hackles.

* The number of companies listed on London Stock Exchange, for instance, fell 75% between 1960 and 2022, according to a 2023 Schroders report.

* Apollo recently signed new private credit investing partnerships with Citi for $25 billion on Sept. 26, and BNP Paribas for $5 billion on Sept. 20.

* New York City crypto-exchange Gemini first filed for approval for a Bitcoin ETF in 2013. The SEC first approved Bitcoin ETFs in January, 2024.