Re-Run: Boaz Weinstein

Saba Capital Management conducted tender offers for OBDC2, a Blue Owl private BDC, and Starwood SREED before either situation had become a major public story. The OBDC2 tender targeted 5% of the fund, which was trading at roughly a 35% discount to its marked NAV. Saba ultimately bid at a 23% discount for Blue Owl and a 27% discount for Starwood, having initially announced a range of 20 to 35%. The outcome of the Blue Owl tender will not be known until April, and Weinstein acknowledged that many market participants expect Saba to receive no shares. If oversubscribed, the next bid would likely be decidedly lower, suggesting adverse selection risk. He estimated a fair value range for the private BDC fund of 35 to 95 cents on the dollar, with a purchase at 65 cents enhancing effective yield to roughly 10.5 to 11% versus 7% at par.

Weinstein argues that NAVs across private credit funds are broadly overstated, both because managers are reluctant to mark down and because observable market prices have declined. He points to JP Morgan recently marking everything down as evidence that other private credit funds should follow. He cites Cliffwater publishing a one-pager in April 2023 claiming an 11 Sharpe ratio for their private credit fund, calling the figure implausible. He attributes the illusion of stability to volatility laundering, a concept he credits to Cliff Asness, whereby illiquidity masks true price movements because funds do not mark to market monthly the way public BDCs do. Some managers have marks on second-lien or non-first-lien positions that differ by as much as 25 points compared to how other funds mark the same positions. He cited Apollo as the most conservative on marks among private credit managers.

The structural liquidity mismatch at the heart of these products is central to Weinstein's critique. The 5% quarterly redemption cap means that in a large sell-off with 40% redemption demand, investors could be exiting at one-eighth of their desired amount and waiting years to fully exit. Cliffwater saw redemption requests rise from 1% to 4% to 14% across successive quarters, with the extra 10% attributed to investor concern about NAVs or fear of gates closing. Weinstein describes a reflexivity dynamic in which falling NAVs lead to larger outflows, forced selling, and further NAV declines, potentially trapping investors for three to four years. SREED has been gated for almost four years, with investors still receiving only partial redemptions monthly. Distribution cuts from private credit funds, specifically from approximately 1% per month to around 84 basis points as SOFR declined from 500 to 350 basis points, triggered the initial wave of retail investor outflows.

Weinstein argues that retail investors did not understand that the liquidity of the underlying assets does not match the liquidity of their investment. He called the large sales commissions paid to private wealth advisors to sell these products a scandal, adding that clients often do not know what their advisor was paid. He cited a prominent fund president who said these products are sold not bought, meaning retail investors did not seek them out. BPRE converted from an interval fund to a stock in December, and investors went from having some liquidity to nursing an additional 30% loss. HPS chose to gate redemptions at 5% even when inflows exceeded outflows, which Weinstein views as destroying brand value. He contrasts this unfavorably with Blackstone, which stabilized BREIT by paying out at the full 100% level and which he also cited positively for how it treated redeeming shareholders.

Public BDCs trading at roughly 60 cents on the dollar make it very difficult to justify private BDCs trading at much smaller discounts. FSK was trading at a 48% discount at the time of the conversation, and even an Apollo BDC trades at roughly a 30% discount. Weinstein notes that BDC managers are paid fees on NAV, meaning investors who bought at a 50% discount are effectively paying fees on roughly twice the price they paid. He argues that buying back shares at a 50% discount to NAV represents a 100% guaranteed return if NAV is accurate, or roughly 60% if NAV should be marked down to 80 cents. He contrasts this with managers choosing to make new loans at 12% rather than buy back shares, characterizing it as fee-motivated self-interest since fees are calculated on assets under management.

Saba is short public high-yield credit derivatives as a tail-protection position, with the private credit discount purchase serving as a partial long offset. High-yield credit has underperformed since the Cliffwater redemption news broke. Weinstein acknowledged this trade carries basis risk because the average high-yield index company is larger and higher quality than a typical private credit portfolio. Goldman Sachs is pitching total return swaps on private credit portfolios to provide more one-to-one hedging. Weinstein also noted that in COVID, investors who could not sell illiquid assets sold liquid ones instead, meaning private credit stress can infect public credit markets.

The private credit BDC space is approximately 700 billion dollars in size, and the broader private credit industry has grown to 2.5 trillion dollars, a scale Weinstein says was partly enabled by problems being masked over an extended period. He identifies rising default rates and NAV recalibration as forces that make it easy to see private credit getting really bad.