The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Stephen Gandel

NEW YORK, March 25 (Reuters Breakingviews) - If a rising tide lifts all boats, rough waters claim the leakiest ships. Cliffwater, manager of the world’s largest private credit interval fund, recently limited withdrawals from its $42 billion flagship, paying out about half of requested redemptions. Others, from Blackstone BX.N to Apollo Global Management APO.N, have done likewise. But the Cliffwater Corporate Lending Fund embodies the criticisms of incautious trend-chasing that grew as the market plowed full-steam ahead.

The familiar private credit mantra is that skilled managers originate loans others can’t and nurture borrowers through tight, bilateral relationships. Cliffwater, though, has about 4,000 holdings, ranging from corporate loans to stakes in other lending vehicles. It sources few directly, instead co-investing alongside partners. In its way, it’s a kind of index fund. This makes sense: Cliffwater provides an index tracking direct loans. In public markets, such tools diversify risk. But when assets are valued by models rather than open trades, it could instead amplify any widespread bias. It gets worse if managers are crowding into the same kinds of investments.

That fear has gripped the market. Artificial intelligence upstarts threaten to displace traditional software vendors. Direct lenders rushed to back the latter during a post-pandemic deal boom, with 29% of business development companies’ portfolios exposed to related sectors, according to S&P Global. As investors woke up to this risk, withdrawals from nontraded credit funds like Cliffwater’s have risen dramatically.

This is where the firm’s unique approach comes under pressure. Roughly 65% of its portfolio is in individual loans, but the remainder is in other managers’ loan funds, whether directly in their BDCs or in securitization vehicles. If peers suffer, so does Cliffwater.

If a borrower starts taking on water, private credit’s advantage is supposed to be that a lender will work closely with them where possible to avoid default. But Cliffwater’s real counterparties are the gigantic firms cutting it in on loans. Managing these relationships – and the vital access they provide – is tricky during a crisis. Cliffwater says it has a 50-person team that evaluates its portfolio daily. Nonetheless, it has marked down the overall value of its book by only 0.1%, according to a year-end filing. That's a little less than claimed by the BlackRock BLK.N Private Credit Fund, and a bit more than Blue Owl’s OWL.N Credit Income vehicle. In other words, it’s in-line with peers.

Cliffwater’s valuation methods are approved by an outside auditor, and it has delivered a healthy 9.4% annual return since the Corporate Lending Fund’s 2019 launch. Still, withdrawal requests hit 14% of net asset value in the first quarter, above the level seen at many blue-chip peers. What once looked like a virtue — indexing the boom in private credit – now looks like an albatross.

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CONTEXT NEWS

Cliffwater told investors on March 11 that it would only pay out about half of redemption requests that it had received in the first quarter from investors in its flagship $42 billion interval fund. Cliffwater, which typically caps withdrawls at 5% of shares per quarter, said that it planned to redeem 7%, versus the 14% that was requested.

(Editing by Jonathan Guilford; Production by Pranav Kiran)

((For previous columns by the author, Reuters customers can click on GANDEL/ stephen.gandel@thomsonreuters.com))