Simplify’s Christopher Getter on PCR

VettaFi recently sat down with Christopher Getter of Simplify Asset Management to discuss the role of private credit in portfolios and the unique structure of the Simplify Private Credit Strategy ETF (PCR), which is currently yielding 12.27%.

Getter outlines four key challenges in the asset class — liquidity, volatility, manager selection, and purity of exposure — and explains how PCR addresses them. The discussion delves into the fund’s proprietary “Quality minus Junk” equity hedge, designed to mitigate tail risk without the negative carry of traditional credit hedges. Getter also draws parallels between current private credit trends and historical emerging market debt cycles, highlighting the importance of structural resiliency over market timing.

VettaFi: For advisors just starting to look at this space, how would you describe the role of private credit in a portfolio, and what makes PCR a compelling option in the current environment?

Getter: Private credit’s attraction is pretty straightforward: You can pick up yield versus, say, investment grade or high yield corporates by lending in the private market. Since most of this issuance is floating rate, an allocation can also reduce your interest rate exposure as well. And because this debt does not change hands publicly, there is a perception that it has lower volatility than corporate bonds.

From an advisor’s perspective, however, successfully investing in private credit entails some important considerations. There are four which I think merit mention.

The first is liquidity: Private credit is a less liquid asset class and we have built in some guardrails to account for that. First, the index comprises private credit-focused Business Development Companies (BDCs) and Closed-end Funds (CEFs), all of which trade daily. Second, we are using Total Return Swaps (TRS) to gain exposure to the index which provides us with a lot of flexibility when it comes to dealing with shareholder activity.

The second consideration is volatility: While many tout the lower volatility of private credit, its seeming stability owes to the lack of frequent trading. This produces “stored volatility” which manifests itself as sharp drawdowns during periods of market stress. To help provide some cushion against these sorts of drawdowns, PCR employs Simplify’s proprietary Quality minus Junk credit hedge, which investors in our flagship Simplify High Yield ETF (CDX) may be familiar with. Having such a hedge may alleviate the need to time an entry point.

Thirdly, manager selection: Similar to other forms of credit, someone must decide which borrowers the fund will invest in. As with any grouping of actively managed funds, there will be some who deliver better results than others. For example, if we look at the 52 BDC and CEF constituents of the VettaFi Private Credit Index, the best performing fund returned just over 25% over the past year while the worst performer was down over 40%. PCR — by taking exposure to the index itself — provides diversification over the entire cohort of managers. In effect, advisors can make an asset allocation decision without the additional burden of undertaking due diligence and making a manager selection decision.

The final consideration is the purity of exposure: Since the SEC limits illiquid holdings to 15% of a fund’s assets, most end up holding marginal exposure to private credit. PCR, by contrast, aims for what I would call more of an “unadulterated” exposure: all private credit, all the time.

VettaFi: When you talk with advisors building out their models, where do you see PCR fitting best? Is this a core fixed-income alternative, a high-yield replacement, or something else?

Getter: Most are looking at it as a part of their alternatives bucket. Some of that might just be the novelty of private credit as the institutional-only barrier breaks down. But the analytical evidence does support viewing it as an alternative. In particular, the correlations with traditional 60/40 type assets are low enough that it pulls private credit more into the alternative space.

Moreover, as advisor model allocations to alternatives have grown, we are having more frequent conversations about how to diversify within the alts sleeve. And here again, the numbers suggest that private credit could play a helpful role.

I’m interested in the fund’s hedging strategy. The website highlights a “Quality-Junk” equity factor hedge. Can you walk us through why the team believes this equity-based hedge is a more effective way to protect against private credit tail risk than using credit instruments directly?

Getter: Sure. To clarify, I am not at all suggesting that credit instruments cannot be effective. But they do have two significant drawbacks. First, traditional “direct” hedges such as credit default swaps can be costly. When you buy protection, you are paying away some spread to hold that hedge which erodes a fund’s return. Second, they require the manager to correctly anticipate the timing of a tail risk event, something which — by definition — is very hard to predict.

The short explanation is that “Quality” factor stocks are those with higher margins, more predictable profitability, and stronger balance sheets while “Junk” factor names are those whose status as going concerns is more sensitive to a rise in financing costs. Because the Junk names are inherently relatively more likely to default, they should underperform Quality names when access to financing becomes constrained; that is, when credit spreads rise.

With that logic in mind, our hedge consists of a long in Quality against a short in Junk. When credit markets have historically experienced periods of stress — “tail risk” as you referred to it — this equity hedge has delivered strong performance, softening the drawdown taking place in credit.

A critical aspect of these factors is that Quality stocks tend to have higher dividend yields than Junk names. This has two interrelated implications. First, even if markets move sideways and we could have done without the hedge for downside protection, it can add modestly to returns, although it may detract in a strong equity bull market. Second, because it has positive carry, we do not need to attempt any sort of market-timing and can hold the hedge structurally in the portfolio.

The key insight is that the most sustainable way for us to deliver long-term outperformance in an asset class that does exhibit the potential for left-tail events is by limiting losses when markets go down sharply. The Quality minus Junk hedge is the most reliable and replicable way that we have found to do that.

VettaFi: Given your background as an emerging markets strategist, what parallels do you see between EM debt cycles and the U.S. private credit market today? And how does that experience inform the way you manage PCR?

Getter: The most obvious parallel to me is that both cycles are a response to banks stepping back from lending, although the drivers are different. Banks had been the most active lenders to governments up until the wave of defaults in the 1980s. Similarly, banks had historically been the dominant providers of credit to middle market borrowers. But the combined effects of Basel III’s increased capital requirements and the Volcker Rule made this business much less attractive to banks. Private credit stepped in to fill the gap.

The takeaways for me are twofold. I see no reason to be alarmed merely based on the increased size of private credit assets. This is lending that was in all likelihood going to happen anyways. At a minimum, moving it into dedicated vehicles like limited partnerships, BDCs, and CEFs adds some level of transparency that was unavailable when banks were the sole lenders.

The second takeaway is more elementary: This is still credit. The primary driver of the spread or additional yield you earn in both cases is the risk that a borrower cannot service its debt. Taking that one step further, there are going to be companies which experience stress and undergo credit events.

In terms of informing how we manage PCR, most of my EM experience centered around finding the countries which offered the most appealing combination of risk and return. This tends to produce portfolios which embed a view on the market. In PCR, we have the flexibility—luxury might be a better word—to build a portfolio which structurally targets resiliency across market cycles by pairing an index-like exposure with the credit hedge we were discussing earlier. And we can do this without the fraught exercise of anticipating which direction the market is headed.

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VettaFi.com is owned by VettaFi LLC (“VettaFi”). VettaFi is the index provider for PCR, for which it receives an index licensing fee. However, PCR is not issued, sponsored, endorsed, or sold by VettaFi. VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of PCR.

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