Should Investors Bite on BlackRock's New PPIP Fund?

On Friday, BlackRock announced plans to allow individuals to invest in the Public-Private Investment Program, or PPIP, which aims to remove toxic assets from banks' balance sheets. BlackRock plans to launch a closed-end fund called BlackRock Legacy Securities Public-Private Trust, which it hopes will trade on the New York Stock Exchange.

According to the prospectus, the fund's objective is to "generate attractive returns for shareholders through long-term opportunistic investments in assets eligible for purchase under the PPIP." The fund will invest primarily in commercial and residential mortgage-backed securities, which must have been issued before 2009 and originally rated AAA or equivalent by at least two agencies. Current ratings are not a limitation, and may be lower.

Should Investors Bite?
According to Morningstar mutual fund analyst Michael Herbst, investors should only consider this fund if they have a long time horizon and are willing to accept the possibility of continued havoc in the mortgage market. He emphasizes that the key risks of mortgage-backed securities still exist. While PPIP is designed to improve markets and bring prices back in line, success is not guaranteed. Investors should be willing to hold onto securities until prices come back in line, which our analysts think could take anywhere from three to nine years. The worst-case scenario--additional mortgage defaults--is a possibility, but BlackRock has shown formidable expertise in selecting these types of securities, and we think the risk of widespread default is low. Investors should also keep in mind that this is a closed-end fund, and the shares may trade below the fund's net asset value even if the underlying holdings gain.

Bottom line: This is a relatively risky investment. While we think the risk of complete default is relatively low, investors must be willing to wait a potentially long time for rewards, and the fund should be used as a satellite holding rather than as a core part of a portfolio.

How It Works
U.S. Treasury involvement will create leverage that could be either beneficial or detrimental to investors, as it would magnify both gains and losses. Here's how this leverage would work:

The BlackRock Legacy Securities Public-Private Trust (the closed-end fund--also referred to as "The Trust") would invest a slice of assets in BlackRock's Public-Private Investment Fund (PPIF or "The LP"), which is a limited partnership private-equity vehicle not accessible to retail investors. The U.S. Treasury will match the amount of money BlackRock raises for the PPIF one-to-one. For example, if BlackRock raises $500 million, the Treasury would invest $500 million--this money is all considered and referred to as "equity capital," and it is all within the LP, or PPIF.

In addition, the PPIF will borrow up to 1/3 of its assets "immediately after giving effect to the borrowing" via the Treasury Debt Financing program. So, if the PPIF then holds $1 billion in equity capital, it will borrow $500 million, resulting in $1.5 billion in the PPIF ($500 million being 1/3 of $1.5 billion).

The closed-end fund itself (The Trust) can only borrow up to 5% of assets to make distributions, according to its prospectus, and the Treasury will not be investing directly in the closed-end fund, but the closed-end fund gives investors indirect exposure to the leverage in PPIF.

Of the funds invested in the PPIF, the leverage works like this:

$1 investment from the PPIF is matched by $1 of equity capital from the Treasury and $1 of Treasury's debt financing such that debt is 1/3 of the total $3.

The $1 of debt leverage is shared by the Treasury and the PPIF, which equals 50% leverage off of the initial $1 investment that each puts in the pot (though the leverage is slightly less than 50% after accounting for PPIF's borrowing costs).

We are not yet sure what percentage of assets the closed-end fund will invest in the PPIF, but if, for example, it invests 40%, the effective leverage would be roughly 20% (40% * PPIF's 50% leverage). The level of effective leverage would change based on the percentage the closed-end fund invests in PPIF.

Government involvement also introduces another element of uncertainty: possible changes in government policy could affect the fund. However, we don't expect surprises for two reasons: 1) we get the sense that lines of communication between the Treasury and BlackRock are relatively open; and 2) the government realizes company participation is crucial for PPIP's success, and is unlikely to alienate BlackRock.

A correction was made to this article since its original publication. For more information, click here.