When various funding advisor and supervisor Cliffwater LLC launched its first non-public credit score fund, Cliffwater Company Lending Fund (CCLFX), in June 2019, few individuals within the wealth administration trade had been listening to alternatives in non-public credit score. Actually, few RIAs had been acquainted with both non-public credit score investments, interval funds or Cliffwater LLC, in keeping with firm CEO Stephen L. Nesbitt.
Whereas the preliminary buy-in from the RIA group was sluggish, the fund now has $20 billion in belongings. It delivered an annualized return of 9.45% since inception and a year-to-date return of 5.65% in 2024. What’s extra, non-public credit score has emerged as one of many hottest various funding choices within the non-public wealth channel, though with some caveats.
In 2021, Cliffwater added one other non-public credit score fund to its portfolio, this time with a concentrate on extra area of interest alternatives. Cliffwater Enhanced Lending Fund (CELFX) offers 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 provide fund launched by Mass Mutual subsidiary Barings in 2022. Cliffwater transformed the automobile into an interval fund and renamed it Cascade Personal Capital. The fund’s focus is on alternatives in non-public fairness, non-public credit score and different non-public market investments, starting from buyouts to personal debt.
WealthManagement.com lately spoke with Nesbitt about how the marketplace for alternate options within the non-public wealth channel has developed over the previous 5 years, how the agency connects with the RIA group and what RIAs ought to know in regards to 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 just a little over 700 U.S.-domiciled registered funding advisors, who in flip present funding providers to their underlying particular person traders. We’ve got three 40 Act funds. We market these to those RIAs, who in flip will put their particular person shopper cash into these funds.
WM: Cliffwater launched its first non-public credit score interval fund in 2019. Are you able to speak about how the non-public wealth marketplace for various investments may need modified from that point interval to immediately?
SN: Initially, it was very sluggish. We’ve form of grown up with non-public retail alternate options. The expansion in our fund is a mirror picture of the expansion and curiosity typically in non-public 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, progress 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 levels of the usage of alternate options throughout the retail sector, and I anticipate continued progress and extra choices by the funding trade within the years forward.
{The marketplace} actually wasn’t acquainted with non-public debt on the time. I wrote my first e book on non-public debt in 2019, Personal Debt: Alternatives in Company Direct Lending, to assist educate each the institutional and the retail market. Principally, non-public credit score and personal debt didn’t exist for most individuals. So, that was a hurdle—getting individuals 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 automobile. The third impediment 5 years in the past was understanding 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 might belief us to execute a personal credit score automobile.
Right this moment, I feel we’ve overcome all three of these hurdles, and that’s why our progress price has accelerated.
WM: How did you determine what kind of fund you had been going to make use of? What made you decide on an interval fund?
SN: There are a selection 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 plenty of paperwork. Personal funds, even some BDCs, require an excessive amount of paperwork—and never solely paperwork, however capital calls, distributions. There’s plenty of complexity and investor qualification going into them. So, the primary issue is comfort. It’s straightforward. You put money into a ticker, and also you make investments the following day.
The second motive was liquidity. The interval fund, not like the non-public fund, not like BDCs, offers the best assurance of liquidity and most liquidity. You will get out below most eventualities as soon as 1 / 4 versus a personal fund, the place you need to wait 5 to seven years. A BDC says they are going to 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 motive we selected the interval funds.
The third motive was we might appeal to the non-qualified investor. We might do this as a result of, like most interval funds, we don’t cost a efficiency price. Consequently, anyone can put money into our fund; it doesn’t require pre-qualification. That’s vital to RIAs as a result of they don’t actually need to discriminate between their traders on who’s certified and who’s not certified.
The fourth motive is the interval fund follows the 40 Act rule, which limits the usage of leverage. And our feeling has at all times been that personal debt must be an alternative choice to investment-grade conventional mounted revenue, so the chance must be low. The leverage limits telegraph to our traders that the dangers on our funds shall be low, significantly in comparison with non-public funds and BDCs, which typically have over a full time period of leverage. Their volatility is far better than the volatility of an interval fund.
I’d add yet one more factor—transparency. As a 40 Act automobile, we’re required to reveal all of our holdings, all of our charges, every part. You hear so much immediately about governmental concern about transparency—is non-public 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; you need to set up a partnership or long-term relationship with them, not like the wires or a few of the banks, the place they’re simply attempting to receives a commission to promote one thing. RIAs are a special ilk and extra institutional-like the place they set up a long-term relationship with their shoppers. We’ve got to do the identical factor.
That meant we needed to construct a direct gross sales drive with Cliffwater staff, not a 3rd get together. Arguably, third-party advertising companies are usually mercenaries, so as a substitute, we went the direct gross sales route and employed our personal salespeople. We employed very expert salespeople, who mainly will not be solely promoting a product however promoting the product throughout the context of an total portfolio. So, after we discuss to RIAs, we’re additionally speaking to them about total asset allocation, what’s happening with not solely their conventional investments, however various investments, and we assist them and supply them with instruments to combine or allocate between non-public alternate options and conventional investments. So, it’s extra of a high-touch kind relationship reasonably than a transactional relationship.
That is what’s distinctive about our strategy. With retail traders or RIAs, a lot 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 companies, however they’re restricted. They should originate their investments. So even when I do know who the perfect agency out there may be, why ought to I simply allocate to that finest agency? I received’t find yourself being sufficiently diversified. It’s higher to take a position throughout a number of managers or non-public fairness companies to attain diversification.
For those who settle for that—and by the best way, a few of the largest pension funds on the planet find yourself investing in 25 to 50 managers—that may be a heavy carry for particular person RIAs to have the workers and purchase the data to determine who the perfect are and allocate throughout a number of funds. That may be an administrative burden. So, individuals rent Cliffwater or put money into our funds not as a result of we originate loans however as a result of we are able to entry loans throughout a number of lenders which have relationships which are skilled. We will diversify to a a lot better 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 carried out in-house or are there extra channels that Cliffwater makes use of to attach with RIAs?
SN: That’s the one channel. On the funding facet, we’ve got 41 individuals devoted to researching lenders and funding companies and executing loans with these managers. After which on the flip facet, we’ve got 27 devoted salespeople centered on relationship constructing with 700 RIAs. After which we even have about 26 admin individuals, who do the block and tackling, the executive work in managing the portfolio.
WM: I perceive that the Cliffwater Enhanced Lending Fund, not like your preliminary Cliffwater Company Lending Fund, focuses on higher-risk methods. Why is now a superb time to try this?
SN: We launched the Enhanced Lending Fund three years in the past, and we’ve got near $4 billion in that fund. Once we take a look at non-public debt, it’s like actual property—many individuals speak about core actual property and non-core actual property. It’s the identical factor with non-public 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 plenty of good managers who do this, and it’s virtually quasi-indexing non-public lending. It’s a really environment friendly market. That’s our flagship fund, the CCFLX.
There are various extra bespoke non-public 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, you need to choose the appropriate 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 with the ability to shift to completely 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, comparable to these raised by Jamie Dimon, about all these non-public credit score funds and what’s going to occur if we’ve got one other lending disaster or downturn. What’s your outlook on dangers that may include non-public credit score investments?
SN: I don’t assume most of those individuals know what they’re speaking about. Jamie Dimon appears to be very sensible about business banking, however I query whether or not he’s educated about non-public debt. Finally, 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. economic system.
The pricing for that ebbs and flows. When individuals be ok with the economic system, spreads are available in, or the yields will not be as nice from the lender’s perspective. And when individuals are spooked in regards to the economic system, or we enter a recession, these spreads widen. These actions in spreads are correlated to default charges. Over the past a number of years default charges have been fairly low. Different occasions, throughout a recession, defaults will enhance. There’s a cyclicality on this market that hasn’t gone away and doubtless won’t go away. No one, to my data, 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 way of good occasions and unhealthy..
WM: Given the place we’re available in the market proper now, and in the event you comply with the recommendation of remaining diversified if you put money into non-public credit score, what sorts of returns can traders anticipate to see?
SN: For those who learn a current paper I wrote, “Direct Lending for the Lengthy Run,” I lay out what I feel the return must be. We predict short-term charges are going to come back 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 plenty of new funds launched lately specializing in non-public credit score. How do you view your competitors within the non-public credit score area?
SN: Competitors is sweet; it’s what makes this nation nice. Competitors retains us on our toes. And fairly actually, we had been one of many first to be promoting to the RIA channel, and being alone in that effort wasn’t good. Individuals questioned why there was only one providing. However now that different individuals have jumped into the pool, individuals really feel extra comfy. “If Blackstone is doing this, if Carlyle is doing this, there have to be one thing to it, so I’ll take Cliffwater extra severely.”
WM: Is there anything that you just really feel is vital for RIAs to remember about non-public credit score investments?
SN: RIAs have struggled during the last decade looking for a secure funding that may have a fairly important yield or money move. It’s been a wrestle post-financial disaster. For those who take a look at conventional funding grade mounted revenue, it returned not far more than 2 to three%, with plenty of volatility. So it hasn’t actually match the invoice of security.
Individuals tried hedge funds for some time, and whereas they’ve carried out just a little bit higher, in all probability 4 to five%, they’re very tax-inefficient and complicated. And there are just a few that do very nicely. That’s been a wrestle.
Money yields till lately have been zero. Proper now, from my viewpoint, RIAs have been given a short-term lifeline with larger short-term rates of interest. However it’s not going to final. It’s going to settle in on the inflation price, which seems 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 non-public debt. What you surrender is modest liquidity. As an alternative of with the ability to commerce it every 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 below most eventualities.
When it comes to asset allocation that RIAs take a look at, it’s virtually a slam dunk that direct lending non-public debt goes to develop as a % of portfolios. Proper now, we see that a couple of quarter to half of RIAs’ non-public alts allocation is in non-public credit score. And we predict that can proceed to develop as a fraction of personal alternate options. I feel the allocation to personal alternate options itself will develop. It should take just a few years, however I feel it can begin to strategy 15 to twenty%.
