Loan Buyer Drops Bid to Widen Investor Base
Marketplace-loan buyer Direct Lending Investments has canceled a bid to convert its only hedge fund into a ’40 Act vehicle — a step that signals potential roadblocks for other firms that are pursuing the method as a way to broaden their investor bases.
The Los Angeles operation notified the SEC last month that it was halting the project. It had submitted paperwork for the conversion at yearend 2015, signaling its intention to open its Direct Lending Income Fund to unaccredited retail investors.
So-called ’40 Act funds, operating under the Investment Company Act of 1940, can accept unlimited numbers of unaccredited investors, but are subject to stricter governance, valuation and reporting requirements than hedge funds.
Direct Lending president Brendan Ross said feedback from the SEC influenced his firm’s decision to cancel the effort. While he declined to offer details of the regulator’s response, he noted that “Level 3 [illiquid] assets can present very, very attractive returns. They are also not what the SEC is used to” for retail investors.
Alston & Bird lawyer Tim Selby added that when it comes to marketplace-loan funds aimed at unaccredited investors, the SEC is concerned chiefly with the liquidity of the assets and how managers assign values to them. “Every conversation I’ve had with [clients] is that it’s not worth it to them. There’s no clear path, and it’s expensive to do a [’40 Act] offering with that risk,” Selby said.
“Once a pathway opens up, you would see a lot more people come out to try to do what they are doing. There’s a lot of interest in marketplace lending . . . They have to get the SEC comfortable. The problem is if the SEC doesn’t like a [’40 Act application] they’ll just sit on it and not clear it.”
Aside from Direct Lending, RiverNorth Capital and VanEck are the only firms known to be planning to offer U.S. marketplace-loan funds to unaccredited investors.
The potential difficulties were discussed by a panel at LendIt’s “LendIt USA 2016” conference in San Francisco in April. Ross spoke there alongside RiverNorth’s Philip Bartow and VanEck’s Bill Ullman, with Alston & Bird’s Selby as moderator.
“The challenges were similar enough that I felt it made more sense to have others pave the way,” Ross said. “It would have been nice to deliver our investment opportunities to retail investors, but it’s not clear how long it would take to succeed and we had other priorities.”
Direct Lending Income Fund launched in November 2012 with just $500,000, and topped $400 million at yearend 2015. It now has $650 million under management.
The growth comes at a time when investors have been pouring money into private debt funds. Such vehicles raised $85 billion last year, the most since at least 2010, according to Preqin.
Direct Lending’s ’40 Act conversion would have seen it offer terms including quarterly withdrawals and a reduction in its minimum commitment to $25,000 from $100,000. The goal was to raise $1 billion to $2 billion, continuing its strategy of buying small business loans from marketplace originators.
Direct Lending Income Fund already is among the largest hedge funds to exclusively employ a marketplace-lending approach. It was producing a year-to-date return of 4.5% on May 31, which was roughly on track with its annualized gain of 12.4% and easily beat a 0.8% rise in Hedge Fund Research’s HFRI Fund Weighted Composite Index. In fact, the vehicle has topped the HFRI index every year since its launch.
The continued profits contrast with a difficult stretch for the broader marketplace-lending industry, where originators including Lending Club and Prosper Marketplace have seen buyers back away from their accounts amid increasing concerns about underwriting practices. But those shops specialize in writing personal loans, as opposed to the small-business loans in Direct Lending’s portfolio.
It remains to be seen how the SEC will respond to ’40 Act applications from other managers. Direct Lending’s plan was to start by using a non-publicly traded ’40 Act format, during which time it would have offered to repurchase the 15-25% of the vehicle’s outstanding shares each quarter at their net asset value. At some later point, it would have held an initial public offering.
Considering the SEC’s concerns over asset liquidity and valuations, it’s possible the regulator would view that process as more investor-friendly than those of RiverNorth and VanEck. The RiverNorth fund, RiverNorth Marketplace Lending Corp., also would hold quarterly tender offers at the Chicago firm’s discretion before eventually going public. But RiverNorth plans to ask the SEC for permission to repurchase those shares at discounts, and hasn’t disclosed what percentage of the fund it may redeem at any one time.
Meanwhile, VanEck would conduct quarterly share repurchases for its Van Eck Coastland Online Finance Fund at net asset value, but only for up to 2.5% of the vehicle. The New York firm had been planning to list the fund on the New York Stock Exchange immediately, but changed its approach last year and now intends to stick with a non-publicly traded structure. The fund also would employ a closed-end format under which it would unwind by 2026, as opposed to raising permanent capital. It’s possible some of the changes reflected objections from the SEC. Coastland Capital is serving as sub-advisor on the fund.