When news surfaced about huge redemption requests at one of Blue Owl’s private credit funds last fall, Angela Miller-May, the chief investment officer of the Illinois Municipal Retirement Fund, immediately reached out to the firm.
The $60 billion Illinois pension fund wasn’t invested in the Blue Owl fund in question, which is a non-traded business development company, or BDC. Such semi-liquid vehicles are marketed to retail investors not institutions. Even so, Blue Owl’s attempt to fix the problem by freezing redemptions in the BDC as it tried to merge that fund with a publicly traded Blue Owl vehicle raised the first concerns about the health of the loans the BDC owned — concerns that have since metastasized throughout the private credit world.The issue for Miller-May was that IMRF is invested in Atalaya, a private credit firm that Blue Owl purchased in 2024. Did Atalaya own any of the same loans as the Blue Owl BDC, she wondered.
“We had to have conversations and discussions with Blue Owl,” she says. “We had to ensure that it was not affecting IMRF’s investments. And after talking to the manager and doing our due diligence, we determined that the redemptions were in fact totally separate from our fund investments.”
Ever since those Blue Owl investors clamored to get out in November, private credit has become one of the most hotly debated topics in financial markets. Non-listed BDCs typically offer investors the ability to take out up to 5 percent of the fund quarterly, with some leeway, but investors have wanted more. After Blue Owl scrapped the earlier merger because of the huge losses it would have created for investors, redemption requests at another one of its funds hit 41 percent, and 22 percent at another. Big redemption requests have surfaced at BDCs run by other brand-name private credit funds, including those offered by Apollo, Ares, Blackstone, BlackRock, Morgan Stanley, and even Cliffwater.
Most of those firms have said they would not give investors all the money they wanted, arguing that caps on redemptions were designed to protect all investors in the funds. But some made concessions. Blackstone recently said it would allow investors to pull a record 7.9 percent of shares from its flagship private credit fund. To a large extent, the redemptions began with concerns about the BDCs’ huge exposure to software companies whose future now seems under pressure from AI. In a surprise move, Fitch Ratings recently said defaults in the private credit universe of companies it follows had hit an average 9.2 percent. And Moody’s has revised its outlook for nontraded private credit investment vehicles to negative. Even funds themselves are being downgraded. In late March, a listed BDC managed by KKR and Future Standard was downgraded to junk status by Moody’s due to what the rating agency called “continued asset quality standards.”
With almost $2 trillion in outstanding loans, private credit is a part of the so-called shadow banking system that touches every corner of the financial system. And U.S. banks, which had lent about $300 billion to private credit providers as of last June, according to Moody’s, have also gotten jittery. J.P. Morgan, for example, marked down the value of the collateral it holds for some private credit firms, limiting how much money J.P. Morgan will lend them, according to a report in the Financial Times. The markdowns target software company loans.
Institutional investors that have rushed into private credit in recent years aren’t directly affected by the BDC redemptions. But the drama surrounding private credit is forcing these investors to take stock of the sector, worrying what effect it could have on their own investments in private credit, even as these funds are continuing to post the returns and low volatility that institutions love.
They also have to worry about how this crisis will affect the entire market. Is this just retail investors being nervous or the harbinger of an impending credit cycle? Is the availability of finance going to shrink, will new investments dry up, and will marked-down values eventually migrate to the funds they own?
No one seems to know where this is headed.
“The largest contributing factor to this situation right now is just that the private credit markets are so opaque,” says Beth Mueller, managing director for the Americas at Suntera Fund Services, an administrator for private credit funds. Under Chairman Gary Gensler, the Securities and Exchange Commission tried to force more transparency on the private investment world, but its 2023 Private Fund Adviser Rules were struck down by an appeals court in 2024, and the SEC did not appeal that decision.
At the same time, less sophisticated investors have moved into private credit, and rules allowing 401(k)s to invest in private assets could bring in even more of these dollars. Such investors have provided much-needed cash to private market firms whose institutional fundraising has fallen off a cliff in recent years.
The ongoing BDC redemptions have even led some to question whether or not these investors should have access to the strategy at all. “Private credit funds really messed it up when they reached out to individual investors,” says short seller Lakshmi Ganapathi, who has written extensively about private credit on her Substack newsletter, Unicus Research.
While institutional investors have the “bandwidth” to deal with the ups and downs of the credit cycle, she says “the problem with retail investors is when there is a fear factor, they want to get out right now because they're not playing with millions of dollars. They do not have the cushion to add to a particular investment when it's going down.” She notes that individuals can get into some of these funds for as little as $2,500. “It looks likes doomsday to them,” she says.
As Ganapathi notes, the good news is institutional investors know that they can stay invested for the long term. As a result, many of them think, as Miller-May puts it, that the private credit crisis “is a little bit overblown.”
For now, it appears most institutional investors are standing pat.
Homyar Choksi, direct lending deputy chief investment officer of CIFC Asset Management, a $47 billion credit asset management firm, says that “on the institutional investor side of it, we have seen no panic, no cause for concern, and honestly no pullback in terms of desire to invest in this space.” CIFC has $4.4 billion dedicated to private credit in middle market direct lending. “The institutional investors have invested in this asset class for a very long time. They're not new to the game.”
At the same time, a number of institutional investors are wary. “We'll see how much this continues to snowball, but our general view is this is probably the early stages of a proper credit cycle,” says Scott Wilson, the chief investment officer of the Washington University’s investment management company.
That could be serious. Credit cycles involve periods of easy, expanding credit, followed by over-leverage, a tightening of lender standards, rising defaults, and eventual recovery. The last significant credit cycle occurred during the financial crisis between 2007 and 2009, and another brief one happened during the Covid pandemic, according to the U.S. Treasury Department.
The problem is not just software either. While the economy is not deemed to be in a recession, Ganapathi notes that many consumers are feeling the pinch. Consumer lending, in the form of auto loans and “buy now, pay later” companies like Klarna and Affirm are themselves financed by private credit, and she says troubles are surfacing there too.
While private credit has been around in some form for decades, it took off following the financial crisis of 2008, after which banks were forced by regulators to pull back on their lending.
The irony is that “the unintended consequences” of pushing lending out of the banking system, where there are theoretically more guardrails, is that lending has been pushed into a “Wild West,” says Phil Zecker, the chief investment officer of Michigan State University’s endowment.
“Buckle your seatbelt,” he quips. “It's only going to get worse.”
An inflection point incurred in 2021 following the collapse of Silicon Valley Bank. “We made one investment in private credit shortly after the collapse of SVB,” he says. “We thought this could be a game changer.” But a lot of other people had the same idea — that bank lending would even dry up at regional banks, and private credit would fill the gap.
Money flooded into private credit, and with so much money chasing deals, spreads narrowed, and terms got worse for allocators. Institutional investors became “term takers,” according to Michael Nichols, who heads private debt investing for the Texas Tech University Endowment. He says that many investors were accepting whatever loan terms were offered because they worried about being left out of the next fund if they didn’t invest.
The power imbalance led to what he calls “ridiculous things” in the big megacap deals that Texas Tech has avoided. “They may say ‘we have covenants,’ but they're written such that they don't have any teeth and they're not worth anything,’ he explains.
One loan covenant that outraged him demanded investors in the fund use one of three attorneys chosen by the fund in case of any litigation down the road.
And in so-called “covenant-lite,” structures, Choksi explains that “there is no financial covenant, like a net leverage covenant or a fixed charge coverage ratio covenant, which monitors and measures financial performance quarter after quarter,” Choksi explains.
Negative covenants limit certain actions by the borrower, such as how much additional indebtedness a company can take on over and above the debt that has been provided or whether it can provide liens to other lenders, he says.
Loose covenants can make the leverage test so high that it is meaningless, adds Nichols. Loose terms lead to excessive risk taking in this segment of the market, which could lead to more defaults and ultimately more losses. And that is worrisome.
“In credit, you can't really afford a lot of these blowups,” adds Nichols. “There’s not enough upside to make up for big losses.” He contrasts private credit to venture capital, where the few winners are so big they make up for the 80 percent of the fund that are “zeros.”
But in private credit, workouts can take three to four years, and tie up capital. “That money’s dead money,” he says. So-called “liability management exercises” — out-of-court, proactive financial strategies used by companies to restructure debt, extend maturities, and reduce interest payments — can mean “you don't really know where you end up in the rank of getting your money back.”
Despite all these potential drawbacks, many institutions say they still love private credit because it can offer equity-like returns with reduced risk. But are the returns really as good as promised?
Critics say such lofty returns can be illusory — in part because they are driven by leverage. “Private credit returns 11.5 percent on loans that yield 9.5 percent. Nobody asks how,” says George Noble, a former Fidelity fund manager and hedge fund manager. “I'll tell you how: Leverage. They take a portfolio of loans yielding 9.5 percent, lever it 2x, and the gross return doubles to 19 percent. Subtract financing costs and fees, hand the client 11.5 percent,” he posted on X. “That's the product Wall Street has been selling to pensions, endowments, insurance companies, and now your 401(k).”
Of course, none of this matters as long as funds can keep from marking down the loans. But, says Noble, “The same people making the loans are the ones deciding what they're worth. When everything's going up, that's a feature. When it turns? It's a trapdoor.”
Wilson agrees. “All the people who thought that they were getting double digit returns for low risk, that's going to turn out to not be true. Historically these things are just not marked to market very well. "There’s little price discovery in private credit. And so the marked-to-market value looks like you have hardly any volatility, but in reality, if they were publicly traded, the volatility would be much higher and they wouldn't show consistent returns like they have on paper.”
This point of view is not an extreme, outsider position. Even John Zito, co-president of Apollo's asset management arm, argued recently that many private market participants are overly confident, stating "I literally think all the marks are wrong.” (Zito’s remarks, made to UBS clients, were first reported by the Wall Street Journal.)
Another question is whether the institutional funds that own the same paper as the listed BDCs will mark down those credits in the same manner as is being done in the public markets. The public marks should eventually be reflected in the marks in the private market, says Nichols. But, in reality, he says, it depends on the valuation policy specific to the institutional fund.
“Different funds can even show different marks for the same credit. Two bonds can look very similar, but they can have clauses in there that are meaningfully different and that can really change the value,” he explains.
For example, an institutional investor might be able to see that a fund owns a senior secured loan to a specific company, adds Wilson, “but you don’t know if the company is three times levered or five times levered.”
And not all institutional investors can demand the level of transparency to tease out these issues. “You underwrite the firm and their process,” especially since it owns a lot of credits and is diversified, he says. “You depend on the process and who they've hired.”
While some publicly traded managers are simply sticking to the rules laid out in fund documents and refusing to honor all redemption requests in their BDCs, others are turning to the secondary markets.
That speaks to an issue Ganapathi says people are missing. Private credit funds, like private equity funds, are dependent on fundraising to meet redemptions in BDCs and investors are reliant on distributions to commit to new institutional funds.
Private credit fundraising peaked at $340 billion in 2021, according to Evercore, the investment bank, and last year the industry raised only $154 billion, as Institutional Investor previously reported.
As fundraising has declined, secondaries have taken up much of the slack. Last year private credit secondaries transactions hit $20 billion, almost double the prior year as investors sought liquidity, according to Evercore.
“Private credit loans are typically repaid as part of an exit event for the company,” Mike Addeo, senior managing director in Evercore’s private capital advisory group told II. “If the company does not exit ahead of the loan’s maturity, the loan is typically extended to provide additional runway for the company to achieve an exit, which has driven longer holds in private credit funds amidst a more muted M&A and IPO environment over the past few years.”
Institutions that do want to exit in a secondary transaction these days will likely take a pretty big discount because of the overreaction to BDC redemptions, says Wilson. “I don't think you're going to get a fair price in the secondary market.”
And sometimes institutional investors “get stuck,” he adds. Not only is there no redemption mechanism for these investors, he says there can be what he calls “recycling provisions.” Even if a loan is sold off, instead of distributing that cash to investors, some fund terms allow it to “recycle” that capital into the fund, he says.
With everything that’s going on, it pays to be extra cautious. Choksi says investors should “look at their [manager’s] underwriting discipline through various credit cycles. Make sure that they have experience managing assets through various credit cycles and know what's in their portfolio.:
Miller-May says IMRF is doing just that. After years of diligence, IMRF initiated has a 4 percent allocation target to private credit in 2022 and established a three- year implementation plan but hasn’t gotten to that level yet. As of year-end 2025, the actual allocation to private credit had only reached 1.8 percent as the overall fund’s size has grown.
The Illinois pension plans to continue to add to its private credit allocation, but in the meantime “we’re keeping an eye on our managers” as well as the portfolio companies they’ve lent to, she says. “We're making sure that the corporate balance sheets are strong. We want to ensure that there's profitability, that there are covenants that are complied with. We look at the loan to value at the average company level. We're just making sure that the manager is investing with quality companies that have those good balance sheets.”
The Illinois pension initially invested in 13 private credit managers across diversified strategies including direct lending, opportunistic lending, asset-backed lending, and distressed lending. The portfolio includes European managers and diverse managers to access international opportunities and middle market exposure.
“We sit down with them on a quarterly or a semi-annual basis,” she says. In terms of private credit, she adds, “we're not really throwing the baby away with the bath water.”
