Money managers hire investigators to find private asset values

Investor faith in private market asset values has plumbed such depths that some are taking matters into their own hands. 

More money managers are hiring investigators for on-the-ground information to help them learn more about the firms they're lending to or invested in, as well as value underlying collateral, according to Jason Wright, senior managing director at financial crimes, risk and regulatory advisory firm K2 Integrity, the corporate investigative firm co-founded by Jules and Jeremy Kroll.

Private credit has boomed into one of Wall Street's fastest growing industries, more than tripling in size in the last decade to $1.7 trillion as money managers gravitated to investments that promised high returns as well as a shield from mark-to-market losses. Historically celebrated for providing stability even when public securities were whipsawing, that attribute is increasingly being seen as a liability as investors fret that untroubled values may not be accurately reflecting true risks.

"There's a lot of discretion used by the managers of these portfolios and the biggest questions we're fielding now are about recoveries in these assets more broadly, and how much can be recovered," Wright said in an interview. "What's the true value of the debt here?" 

In February, Bloomberg News reported that in some cases the exact same loans were being marked wildly differently depending on whose portfolio they were in. The huge variations in pricing is also spooking regulators who are concerned that a lack of consensus may be masking more distress under the surface.

READ MORE: Clients want in on private markets. Should advisors hold their hands?

A growing trend within private markets has been the rise of so-called business development companies, which are essentially closed-end funds that invest in small- and medium-size private companies, and are often publicly traded. Demand for non-traded private BDCs as well as other private and semi-liquid vehicles, where money changes hands at the marks the managers have decided, has also sky-rocketed in recent years. 

Business development companies own approximately 40% of all deployed private credit in North America, according to a January research paper published by Barclays. That represents assets under management of around $315 billion, according to Corry Short, a Barclays strategist, who coauthored the report. 

"Interest in private markets more broadly, and how business development companies mark their assets have been a key interest of clients lately," Wright said. "Now we have large funds asking, have these valuations within private markets and credit portfolios been tested, and how can we test them?" 

BDCs also invest in distressed companies. They are open to retail investors and are becoming ever-more popular among pensions, insurers and family offices, as well as other international institutions.

To be sure, increasing numbers of lenders pay third-party valuation specialists to look at their marks, and funds are routinely audited.

However, recent fundraising data shows that some of the edge has been taken off the dizzying rise in private credit, spurring some BDCs to start cutting fees to help keep capital coming in.

Some investors are going a step further and betting directly against BDCs to capitalize on any future losses. 

There was $439 million of new short selling activity year-on-year against the funds, an increase of 37%, according to data from S3 Partners, a financial analytics firm. Overall BDC short interest is $1.32 billion, representing 3.85% of the short interest float.

"In some extreme cases, we're seeing cases of lending terms being too good to be true," Wright said. "When investigated, it turns out that the collateral being promised to investors for lending has in fact been pledged to others. Sometimes multiple times over."