Investors in a private debt fund managed by Cortland Credit Group Inc. recently learned that they could no longer take their money out, the latest in a string of redemption freezes that is raising questions about how often investors are left in the dark.
The practice, known in the industry as “gating,” allows fund managers to prevent investors from pulling out their money to preserve the fund. While gating is typically disclosed in offering documents, it can come as a shock to investors who believed that they would have relatively easy access to their cash.
Private debt funds are alternative lenders, and their borrowers are often higher-risk companies that can’t access credit from traditional financial institutions. The funds typically charge interest rates above 10 per cent annually.
They have grown in popularity in recent years, particularly in the years of ultralow interest rates, in part because they often pay monthly distributions and advertise yields higher than those available from traditional bank products. They are sometimes marketed as a way to earn steady income with less volatility than stocks.
But critics warn that these alternative investments can come with higher risk, steep fees, limited transparency, and that many retail investors may not fully understand what they are buying into.
Private debt manager Cortland halts investor redemptions over trouble with a large borrower
Historically, private debt was the domain of large institutional investors willing to lock up capital for years at a time. Over the past decade, however, access has broadened, particularly in Canada, where demand for income-generating investments has surged.
“These are risky products, and they are sold as being safer than equities but bigger returns, and that should be a red flag,” said Benjamin Felix, chief investment officer and portfolio manager at PWL Capital, who has been critical of private funds hitting the retail market. “Most retail investors don’t have the financial acumen to understand these products.”
Before investing in private debt funds, experts say retail investors should understand several key risks.
However, it can be tough for investors to independently assess performance and risk of these investments. Unlike public mutual funds, which report their value daily, private debt funds update valuations far less frequently and disclose fewer details about their holdings, Mr. Felix said.
In addition, private fund managers are not always required to publicly report major developments, such as a key borrower filing for bankruptcy or restructuring under creditor protection.
In early 2024, Independent Energy Corp., a Saskatchewan-based diesel-fuel refinery, was the largest borrower in Cortland’s private debt fund, owing $229-million. After IEC defaulted on its loan and filed for creditor protection, Cortland’s investors had limited visibility into the problem when reading the fund’s two-page quarterly summary.
Private funds are also typically illiquid, meaning that the underlying investments, which are often loans to private companies, cannot be easily sold. While a fund may offer monthly or quarterly redemption windows, it can still reserve the right to suspend withdrawals if too many investors ask for their money back at once or market conditions put strain on the company.
“A lot of the time when you need the assets, you won’t have access to them,” said Andrew Feindel, senior wealth adviser at Richardson Wealth Ltd.
Fees can also be significantly higher than those charged by traditional mutual funds or exchange-traded funds. Investors often pay both a management fee and a performance fee, Mr. Felix said, which can eat into returns over time.
The role of financial advisers has also come under scrutiny. In a LinkedIn post, Harold Geller, a lawyer specializing in financial-loss litigation at Geller Law in Ottawa, said that advisers face structural challenges when recommending private investments that are sold outside public markets, known as exempt market securities.
“Rarely, if ever, can a financial adviser perform their mandatory duty to ensure that a recommendation to purchase, or even facilitating your instructions to buy, an exempt market security is suitable for you,” Mr. Geller wrote, citing limited public disclosure and the difficulty of performing meaningful due diligence.
Advisers are required by regulators to disclose the material risks that come with private debt fund investments, but that’s not always done in plain language.
In an interview, Mr. Geller said that there is a “fundamental conflict” because advisers can earn higher compensation for selling exempt market products, creating potential conflicts of interest that can undermine their duty to act in an investor’s best interest.
