The Growing Concerns Around Private Credit
Private credit has consistently met the expectations of investors, delivering steady returns, low volatility, and attractive income. However, despite this apparent success, a growing number of investors are starting to pull back, submitting redemption requests and realizing that liquidity in private credit is more limited than they anticipated.
At first glance, this shift seems confusing. Why would investors leave something that appears to be working well? The answer lies not in the realized performance of the credit but in the interaction between the structure of these investments, investor expectations, and their behavior in uncertain environments. What may seem like a liquidity or credit issue might actually reflect how investors respond to uncertainty in less transparent markets.
What Changed the Narrative?
The recent shift in sentiment was triggered by a small number of high-profile problem loans. While these situations were largely idiosyncratic, the media coverage around them altered public perception. An asset class once seen as stable and income-focused began to raise new questions: What risks might still be hidden?
Notably, the reaction from investors has far outpaced the actual losses incurred. These events have also reinforced a broader concern that the growth of private credit has been too rapid. More capital has flowed into the space, competition has increased, and the opportunity set has expanded. As a result, there has been renewed scrutiny on underwriting discipline and the structure of these investments.
These concerns are reasonable, but they are mostly forward-looking and depend on specific implementations. There isn't clear evidence of widespread deterioration in the sector.
When Concern Turns Into Action
Two main issues dominate the current discussion: illiquidity and credit risk.
Evergreen private credit vehicles often offer periodic liquidity, even though they invest in inherently illiquid loans. This structure is intentional, not an oversight. The underlying assets are meant to be held through economic cycles, and the fund design reflects that reality.
During periods of high redemption activity, the mismatch between offered liquidity and the liquidity of the underlying assets can become more visible. When gates are triggered, it is sometimes described as a breakdown of the structure. In practice, gates function exactly as intended. They are designed to limit forced selling, preserve long-term value, and protect remaining investors during times of market stress.
Illiquidity has always been a core feature of private credit. It exists to align investor expectations with the long-dated nature of the underlying assets and to allow managers to underwrite, structure, and hold capital without being forced into suboptimal exits. In that sense, reduced liquidity is not a flaw in the system—it is central to how private credit is designed to work.
What many investors are experiencing is not the emergence of a new risk, but a renewed awareness of the trade-offs embedded in the structure.
Behavior and Assumptions About Liquidity
From an investor’s perspective, the logic feels reasonable. Returns look fine, risks may be building, so why not step aside and re-enter later?
Evergreen structures subtly reinforce this thinking. The ease of entry creates the perception of ease of exit, even if that proves incomplete. Redemption rights exist, but they are conditional on collective behavior.
The issue is not illiquidity itself, but the assumption that liquidity will always be available precisely when it is most desired.
Individually, these decisions are understandable. Taken together, they can create pressure that is driven more by behavior than by changes in underlying credit performance.
This distinction also helps explain why outcomes have varied across vehicles. Much of the most visible pressure has occurred in publicly traded business development companies, or BDCs, whose shares are marked to market and reflect interest rates, liquidity conditions, and investor sentiment on a daily basis.
Non-traded private credit vehicles tend to behave differently. Their valuations are driven primarily by realized loan performance and collateral, rather than daily market pricing. As a result, price movements in BDCs reflect how different structures transmit stress, rather than serving as a direct signal for private credit valuations.
A Misunderstanding of Portfolio Role
What is notable is that the fundamental reasons many investors allocated to private credit have not materially changed.
Private credit was not intended to function as a trading vehicle or a source of tactical flexibility. It has typically been used as a diversifier within credit, offering higher income in exchange for reduced liquidity. That trade-off was explicit at the time of allocation.
Periods of heightened uncertainty, however, often shift attention away from portfolio construction and toward timing. Assets selected for their role within a diversified portfolio can begin to be evaluated in isolation, contributing to shifts in behavior that are not necessarily driven by fundamentals.
Putting Downside Risk in Context
Concerns about economic vulnerability are reasonable. Credit losses do tend to rise during downturns. Context, however, is important.
Private credit generally sits higher in the capital structure than equities, which absorb losses first when economic conditions deteriorate. During the Global Financial Crisis, global equities (MSCI ACWI Index) declined by more than 50% from peak to trough. Over the same period, private credit (Cliffwater Direct Lending Index) experienced a drawdown that were closer to one-fifth of equity losses. The next economic downturn could certainly be worse, but seniority in the capital structure has historically played a meaningful role in moderating downside relative to equities.
For investors concerned about macroeconomic weakness, it is worth considering that equities are both fully liquid and more exposed to earnings declines and valuation compression. As a result, reducing equity exposure may be a more direct way to address concerns about downturn-driven losses than adjusting allocations to senior, less liquid credit.
Private Credit Is Not One Market
Another aspect often overlooked in the current discussion is the breadth of the private credit universe.
Recent concerns have been concentrated in sponsor-backed corporate lending, particularly in cash-flow-driven businesses. Roughly 20% of direct lending is tied to software, and many newer funds have focused on this segment.
Sponsor-backed corporate lending represents only one segment of the private credit market. Other areas are less reliant on near-term cash flows. Asset-backed lending, including real estate lending, relies more heavily on collateral, contracted revenues, and amortizing structures, and as a result can behave differently across economic cycles.
Some have described the current environment as the beginning of a private credit unwind. That interpretation likely overstates the case.
This episode appears less indicative of a fundamental breakdown and more reflective of a behavioral stress test, where structure, expectations, and investor response are interacting with uncertainty.
Private credit itself has not fundamentally changed, nor has the role it has historically played in portfolios. What has shifted is how investors are responding to uncertainty, particularly when liquidity constraints become more visible. The asset class is operating as designed, even as those design features are being reassessed in real time.
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