By Amit Seru

About the author: Amit Seru is a senior fellow at the Hoover Institution and the Stanford Institute for Economic Policy Research and a Steven and Roberta Denning professor of finance at the Stanford Graduate School of Business.

What happens when asset managers promise daily liquidity on portfolios filled with illiquid loans, then start marking those assets based on guesswork? What happens when those guesses diverge from reality -- and that divergence starts moving markets? We may soon find out as the world of private credit exchange traded funds booms.

Private credit was once reserved for institutional investors. Now it has gone retail. Through business development companies and a wave of new private credit ETFs, everyday investors are gaining exposure to opaque, hard-to-value loans to middle-market firms. These loans don't trade. Their valuations are model-driven. And when markets turn, models can become fictitious.

We have seen this movie before: Structured investment vehicles in 2007. Gated real estate funds after Brexit. Corporate bond ETFs in 2020. Each time, the illusion of liquidity and stable asset values was shattered in a flash.

The risks of liquidity mismatches and leverage are well-known. But a deeper, underappreciated threat looms: valuation contagion .

Private equity and private credit platforms rely on internal marks to report performance, secure financing, and raise capital. But when affiliated or similarly structured ETFs begin trading at steep discounts to their net asset values, they broadcast a message the rest of the market can't ignore: The emperor may have no clothes.

Sponsors wave off the gap as "temporary noise." But if it lingers, questions snowball. Limited partners hesitate. Banks reassess collateral values. New fund-raising dries up. Credit lines get pulled. It isn't a liquidity run; it is a credibility run. And it spreads fast.

ETF discounts don't just embarrass sponsors. They can also upend the financing ecosystem that supports these funds. Many private vehicles' subscription lines are based on NAVs, and use margin facilities and warehouse financing. A sudden loss of NAV credibility raises risk flags, tightens covenants, and forces asset sales into shallow markets. What begins as a mark-to-model problem ends as a cash-flow crisis.

This isn't just theory. In real estate, hedge funds, and even crypto, persistent NAV deviations have triggered margin spirals and asset fire sales. What's different now is the scale and structural interconnection. While only one firm has filed to launch a private credit ETF so far, others may follow. Many of these firms rely on similar technology platforms, shared market infrastructure, and overlapping investor bases. Even without formal integration, valuation distress in one vehicle can ripple through expectations across the system.

The ETF wrapper, once sold as a transparency upgrade, may become the mechanism that exposes how little we know. When shares trade consistently below NAV, the market is passing judgment on internal marks. And the market doesn't wait for quarterly updates.

Worse, we don't know who is responsible when things go sideways. Many ETF sponsors have informal "liquidity backstop" agreements with affiliated parties, but these are rarely disclosed. Some sponsors quote prices through third-party valuation agents that rely heavily on inputs from the sponsors themselves. This isn't price discovery; it's pricing by echo chamber.

Regulators cap illiquid assets in ETFs, but those limits aren't as effective as they might seem. Portfolio liquidity classifications are often self-reported, based on optimistic assumptions about "time to sell" under normal conditions. That framework breaks down fast under stress. As long as NAVs are based on hypothetical sales in nonexistent markets, even formally compliant ETFs can create the illusion of daily liquidity where none exists.

The growth of private credit ETFs is global, with funds domiciled in Luxembourg, Ireland, and Singapore marketing to international investors. European regulators face similar opacity but lack harmonized standards. Sovereign-wealth funds and pensions, from Canada to the Gulf, have poured capital into platforms that all depend on the same performance metrics and valuation trust. If NAVs lose credibility in New York, they lose credibility in Oslo, Abu Dhabi, and Toronto, too.

Policymakers need to act. That starts with public disclosure of the authorized participants, their contractual obligations, and formulas to calculate NAVs -- especially during times of stress. Regulators should require transparency around cross-holdings between ETFs and private vehicles. They should subject these structures to global stress tests that reflect real-world redemption pressure and counterparty risk.

Transparency alone won't solve the problem. The structure itself is flawed. These vehicles offer daily liquidity on portfolios that may take months to unwind. That mismatch doesn't go away just because the small print got longer. Regulators should consider limits on illiquid asset exposure for ETF wrappers, standardized gating mechanisms, or reforms that restrict what can be labeled as "liquid" in the first place.

The world also needs real-time, cross-border data infrastructure that tracks valuation gaps, leverage, and redemption channels across all private credit vehicles, regardless of domicile. Without it, capital will chase opacity. Regulatory arbitrage will magnify systemic fragility.

Private credit itself isn't the problem. The danger comes from wrapping illiquid, model-valued assets in retail-facing structures that promise daily liquidity. Regulators shouldn't wait for damage from soured promises to go systemic. They should act now to ensure the trust anchoring these vehicles is earned, not assumed.

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June 25, 2025 11:58 ET (15:58 GMT)

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