A Closer Look at a Groundbreaking Active ETF Proposal

State Street and Apollo Global Management filed to launch an actively managed exchange-traded fund that invests in public and private credit, the first ETF of its kind.

The announcement raised a flurry of questions while the SEC decides whether to approve SPDR SSGA Apollo IG Public and Private Credit ETF. Here’s what you need to know about the filing and what it means for investors and the ETF industry.

What will this fund do?

This fund aims to invest in public and private credit in one ETF portfolio. Public credit describes fixed-income securities like corporate bonds, mortgage-backed securities, syndicated bank loans, and more. It’s familiar terrain for ETFs.

The novelty lies in the fund’s allocation to private credit, a burgeoning corner of the investment universe. The International Monetary Fund estimated that US private credit reached $1.6 trillion at the end of 2023, fueled by low bond yields and tighter lending standards among commercial banks.[1] That growth came without any retail money. Private credit is out of reach for most investors because it requires high investment minimums and long lockup periods.

The proposed State Street/Apollo product would change that. Other ETFs have attempted to offer private credit exposure through public investments, but this one would be the first to hold private credit directly—a strategy that comes with challenges.

What is private credit?

Private credit is an umbrella term that covers a wide range of investments, from corporate direct lending (the most common) to music royalties and equipment financing (so-called asset-backed lending). These instruments typically pay a floating-rate coupon, like syndicated bank loans or floating-rate Treasury notes that are commonly found in traditional bond mutual funds. Those floating coupons have softened the impact of rising interest rates in recent years, which helps explain some of the growing interest in private credit.

For a couple of reasons, the ETF likely will invest across the private credit market rather than just in the corporate direct lending market. First, Apollo has the capability to invest beyond corporate direct lending across the whole private credit spectrum. Apollo reported $671 billion in assets under management as of March 2024, the bulk of which was credit, and has 16 distinct platforms for originating debt.

Second, different kinds of private credit instruments have different profiles. That includes levels of liquidity, different maturities or amortization schedules (if securitized), different market betas, and so on. A well-diversified portfolio of private credit is likely to hold up better over time than a narrower portfolio.

Why haven’t these launched before?

Private credit is illiquid. Typically, these instruments are wholly owned by the lender, unlike public credit instruments, which are widely held across mutual funds, ETFs, insurance companies, and other investors. 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; potential counterparties need to underwrite and analyze the instruments from scratch. That takes time when done responsibly.

Valuation presents another potential issue. Private credit managers typically rely on third-party firms to value their investments given that they rarely trade, if ever. It’s not yet clear if this ETF will use a third party in addition to Apollo’s intraday bid to help price and set the ETF’s net asset value.

How does it plan to overcome those obstacles?

Apollo has entered a contractual agreement with the fund to act as a liquidity provider. It will provide private credit instruments for the fund to buy and provide it with “intraday, executable firm bids” on all its holdings. Apollo has further agreed to purchase those private credit instruments from the fund up to an undefined daily limit. In other words, Apollo is selling these instruments to the fund and promising to buy them back at the request of State Street. The liquidity agreement itself seems to apply only to providing bids and the obligation to purchase from the fund, not to the initial sourcing of these instruments.

It’s a novel approach for offering illiquid private credit instruments in an ETF, which needs prices to value its holdings daily, and a reliable mechanism for trading those securities in and out of the ETF to work, let alone gain SEC approval and investor confidence.

What’s the problem?

This approach raises several concerns. One is that this liquidity agreement arguably makes these private credit instruments liquid because there’s a contractual intraday executable bid. The SEC limits open-end funds’ illiquid holdings to 15% of assets and defines illiquid as “an investment that the fund reasonably expects cannot be sold in current market conditions in seven calendar days without significantly changing the market value of the investment.” State Street may hope the intraday bid solves the seven-calendar-day problem. In its filing, State Street admits that if Apollo can’t provide bids for its private credit instruments, “assets that were deemed liquid by the advisor may become illiquid.”

So, it appears that State Street is relying on Apollo, not only to sell private credit instruments to the fund but also to offer executable, intraday bids that will allow these normally illiquid investments to meet the SEC’s definition of liquid holdings. The risk is that swaths of the portfolio deemed liquid could become illiquid if Apollo fails to provide the bids.

What’s the other problem?

It’s possible the fund could have to meet way more redemptions in a day than Apollo’s promised liquidity limit. That could force State Street to sell more-liquid public securities first, in turn potentially leaving the ETF with more in illiquid private credit instruments as a percentage of assets and increasing the risks for further liquidity crunches. When this happens, the portfolio often begins to manage the advisor, rather than the other way around.

If redemptions are greater than Apollo’s liquidity capacity and the ETF has few public securities, there are many more questions that the filing doesn’t answer. Authorized participants may be reluctant to accept private credit instruments for in-kind redemptions, potentially forcing State Street to draw on a line of credit for bridge financing, directly inject its own capital into the fund, or ultimately shut down the fund.

A lot depends on Apollo’s daily liquidity limit and its ability to satisfy it as the ETF grows.

What does Apollo get out of this?

Another concern is the relationship between State Street and Apollo. The fund’s prospectus offers some details, but answers are missing to some key questions. Apollo is not listed as an advisor or subadvisor, and the filing does not disclose any reference to a financial arrangement between the fund and Apollo. This doesn’t preclude an agreement between the firms, but it does raise the question of how Apollo is being compensated for its services.

If Apollo is the sole provider of private credit instruments, both delivering them to and buying them from the fund, this raises many questions about fairness and Apollo’s compensation that are not answered in the current prospectus. The prospectus also doesn’t give enough information to explain why this arrangement won’t violate self-dealing rules.

And what about State Street?

State Street’s benefit is, in short, fee revenue. This fund probably won’t charge the astronomical fees of private credit funds or a portfolio of business development companies, but its fee is sure to exceed the average taxable-bond ETF’s 0.31% fee. If mainstream investors embrace the private credit ETF, State Street could reap a healthy stream of recurring revenue.

It has paid to be first with ETF innovations in the past. The first spot bitcoin ETFs racked up more than $15 billion of inflows within two months of launching, for example. The demand for private credit ETFs probably isn’t anywhere near that of cryptocurrencies, but State Street would surely benefit from a head start. They aren’t alone: BlackRock and others are looking at private-investment ETFs.

Why should investors care?

The public and private credit markets have much more in common than public and private equity and have gotten closer in recent years. As more money has flowed into private credit, larger corporate borrowers that were historically limited to raising money through banks have been able to meet their financing needs through the private market.

Going forward, savvier or larger borrowers are likely to toggle between the public and private credit markets based on cost and need. Many asset managers are hoping to capitalize on investor desire for exposure to this growing slice of the credit markets. For example, Capital Group and KKR recently partnered and plan to launch an interval fund in 2025 that invests in public and private credit. Interval funds don’t face the same liquidity demands as ETFs.

What does this mean for the ETF market?

The State Street-Apollo venture is sure to be just the first of many private-market ETF proposals. BlackRock has announced a private-investment model portfolio with private equity firm Partners Group. Invesco and Goldman Sachs have kicked the tires on private investments in ETFs.

This filing brought the private debt ETF arms race to the SEC’s doorstep. Whether the regulator approves it remains to be seen.

Final Thoughts

State Street and Apollo, Capital Group and KKR, BlackRock and Partners Group, and others are attempting to capitalize on investor demand for private assets. As more companies raise equity and issue credit in private markets, investors who want complete market exposure may want to access private markets.

However, there are several issues with this proposed ETF, all of which boil down to the fact that one firm (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. The ball is now in the SEC’s court.

[1] International Monetary Fund. (2024). Global Financial Stability Report: The Last Mile: Financial Vulnerabilities and Risks.