The Hottest Party On Wall Street Is One You Might Not Want An Invite To

If there is one thing Wall Street loves, it is a hot new trend that promises high returns, exclusivity and limited correlation to the stock and bond markets. The latest products? Private Credit, Private REITs (Real Estate Investment Trusts), and anything else that is not traded on a public exchange.

Our firm, LCM Capital Management, wrote an article for Benzinga only a few months ago talking about what is happening "off market" with stocks, Dark Pool – Shrouded Exchanges.  These new private alternative investments are raking in billions from institutional clients and now Wall Street wants to bring it to mom-and-pop investors. I recently read an article talking about these becoming an option within your 401(k) plan. After all, it is what investors want, right? I mean who wouldn't want steep fees, questionable liquidity all with risks that are—ultimately—understated. As Jason Zweig recently wrote in the Wall Street Journal, "Hold on to your wallet. Wall Street is gearing up for a sales push that could enrich the middlemen and impoverish you."

If you have read any of our Benzinga articles, you know our firm has a very skeptical take on the financial industry and the products it creates and pushes. We are firm believers in the theory that most investors don't look to buy these products, they have to be sold to the client. The bet is most investors have not reached out to their broker or advisor to inquire about these investments.  Yet it would not surprise us that you received a call from someone about buying this investment and if you have not, you will. 

Private Credit really started to emerge back when interest rates where near zero (post financial crisis 2007-08) and institutions were desperately looking for ways to earn more on their money. So what did our industry do? They solved the problem by creating a new market, Private Credit. As a result, all of the big players are now piling in, Blackrock, Goldman, State Street, Apollo, Pimco, KKR, Blue Owl, JP Morgan, and others added weekly. This is actually interesting since JP Morgan's CEO, Jamie Damon, was warning anyone who would listen about this new investment being created and how it is not a good thing, but as you might recall, he said the same thing about Bitcoin initially. Massive fees and very little oversight, and throw in the allure of returns 7% – 10% and non-correlation to the markets you have the perfect product – what could possibly go wrong?

One of the great things for the issuers/sellers of these products is all in the name, "private." Since the holdings don't trade publicly, valuing these investments is left up to the manager. That's like putting the fox in charge of the hen house. Rob Copeland and Maureen Farrell wrote an excellent article in the New York Times online, Wall St is Minting Easy Money from Risky Loans, stating "Because private credit firms don't have to regularly reveal their loans to regulators, they can create their own rules for how to "mark," or value, their portfolios." Hard to underperform when you make the rules and because most of these investments are illiquid, you don't run the risk of a run on the bank.  Take Blackstone's private REIT (BREIT), for example. When investors rushed to withdraw funds in 2022, the firm imposed withdrawal limits, leaving many unable to access their cash. These agreements are packed with clauses that let fund managers freeze withdrawals or restrict access whenever markets get rocky—in other words, right when you might need or want your money the most. You didn't know that? Sorry, It was right there in print, buried within the 300+ page prospectus that I am certain your advisor sent you and told you to read.

Do you find it interesting that the CEO's and top executives at these companies are billionaires and Deca-billionaires? Are you?

Private Credit is different from regular bonds or public loans because it means lending money directly to companies. These loans usually come with higher interest rates and fewer rules. It might sound like a great investment: steady returns, access to exclusive markets, and a supposed hedge against stock market chaos. That is why all these firms have been raising record amounts of capital for their private funds. But there is a catch—investors are locking up their money in opaque investments with little control over when or how they can cash out and the risks are truly unknown.

In the late 90's or .com era, there was a stock creation called "blank check" companies. These "companies" did not own or create anything but their intention was, they would eventually figure out what they would be.

In the mid-2000s, big Wall Street banks created yet another product to fill the supposed needs of investors since interest rates were near zero. I think most everyone reading this recalls the subprime mortgage crisis? Wall Street re-packaged and marketed consumer backed mortgages as a low-risk highly-rated financial investment. Many banks had to be bailed out. Once again, what could go wrong?

During Covid, "blank check" companies made a comeback this time under the disguise of a SPAC (Special Purpose Acquisition Company), again not knowing what they would be, but they would buy something and figure it out. Many went out of business or close to it, some succeeded but at least they were public. You at least could see how much money you were losing.

Today, here we are yet again, a few years later. Wall Street is on the prowl with the promise of plenty of money to be made outside the stock and public bond markets. The problem is, you might not be the one making the money. My partner and I have each been in this wonderful business for over 37 years and any time we see a product that only institutions had access to but now is being made available for the non-institutional investors, it typically does not end well. We are sure there are a few very well-run private credit funds but just like in high school, when all of your friends and then friends of friends got word of a party with no parental oversight, well you know how those ended. 

Wall Street has a long history of packaging and marketing high-risk products as must-have investments. Private Credit, private REITs, and private equity placements are just the latest iteration.  Perhaps they have a place in a portfolio – institutions with deep pockets and long-term time horizons that can absorb the risks. For everyday investors, the promise of high returns often masks steep fees, liquidity traps, and underappreciated risks.

Before you invest in private markets, ask yourself, are you doing it because it makes sense for your financial plan, or just because it is the latest trend on Wall Street? More often than not, the answer should have you running away.

If you would like a product with high commissions, high management fees, high leverage, high interest rate costs, high incentive fees, illiquid gated/restricted vehicle and distributions a majority of which are taxed as ordinary income along with estimated values, then maybe private credit is for you.

There is a better way!