Private Credit

Private credit funds under scrutiny

Redemption requests at Private Credit funds have increased of late following several years of strong growth and performance. This has led to a lot of column inches being dedicated to the challenges within this market, and questions raised about pressures building up within global financial systems that may create another event like the 2007-09 global financial crisis (GFC).

Before explaining why we believe that these concerns are overblown it is important to make the distinction between Private Credit and Private Equity. Private Credit is direct lending or loans made by non-banks to businesses whereas Private Equity is owning part of a business. They sit on opposite sides of the capital structure, with Private Credit funds owning debt (also known as credit) and Private Equity funds owning equity. Confusion can arise when Private Equity funds invest in Private Credit funds.

What is driving redemptions

There are several reasons for the increase in private credit fund redemptions, but two key factors dominate. Firstly, there have been redemptions based on concerns about the wider lending standards in private credit following elevated levels and rapid capital raising of recent years. The second key factor is due to funds with large exposures to the software sector, where the potential for AI disruption has become much more acute following Anthropic’s recent product releases.

Private Credit loans are usually floating rate, privately negotiated, held to maturity (5-7 years) and illiquid. Direct lending primarily finances private, mid‑market companies which are not typically a part of the market serviced by banks. These firms’ credit rating would largely be equivalent to high-yield debt markets.

While the global Private Credit sector has grown nearly tenfold since the early 2000s, with especially rapid growth since 2020 as banks retrenched and investors sought floating rate income, it remains many times smaller than public bond markets. Private Credit has approximately $3tn in AUM (direct lending account for around half of this) whereas the global bond market exceeds US$130tn — more than 40X larger!

Understanding private credit markets

Recent headlines have been quick to focus on the mismatch in liquidity of Private Credit and the ‘semi-liquid’ vehicles in which they sit. However, the majority of Private Credit AUM is held in traditional 10-year, drawdown funds, where capital is provided by sophisticated investors and locked up until a fund winds up.

Premium yields have attracted less sophisticated clients to these funds who may be more susceptible to redeeming capital over short investment periods. “Semi-liquid” vehicles offering periodic liquidity, often quarterly, have contributed to the recent growth. Although it is natural for an asset class that has grown strongly to face scrutiny, it is estimated that only 11% of total private credit AUM is held in ‘semi-liquid’ structures. Therefore, redemption pressures are largely contained to a small part of the asset class.

Liquidity mismatch?

The recent pick up in redemptions from private credit funds, has to date been concentrated in several US-listed funds called Business Development Companies (BDCs). These requests have exceeded the 5% quarterly redemption limits meaning funds have gated, restricting total redemptions, with excess capital demands rolled over. While this has attracted negative headlines, we believe it is the correct course of action and follows liquidity management terms outlined in prospectuses. This helps to protect value for remaining fund investors.  Evidence of forced selling at distressed prices remains limited and is something to be watched if redemption requests persist. Outside of BDCs, outflows from other evergreen private credit structures appear modest to date.

Credit quality remains resilient

Following such rapid growth, there have been concerns that looser credit underwriting standards have crept in as speed of deployment may have been prioritised over borrower quality, particularly in recent vintages. However, current indicators of credit problems remain limited. In high-yield credit markets defaults should be expected especially off historic low levels. There has been a small pick-up in bad loans. Non‑accrual rates average 1.8% in the BDC market, broadly in line with long‑run experience and early signs of impairments remain contained.

Widespread marks below US$80 cents (prices <$80cents is categorised as default) remain uncommon and there is limited evidence of broad price-led contagion into public markets to date. The latest data suggests just 6% of BDC exposure is reported at a Fair Value below 80% of par. It is also worth noting recovery rates (the percentage returned in the event of a default) in the private credit sector tend to be 60-70% on average. Senior positions in the capital structure, large equity cushions, covenants and lender’s focus on short-term cashflow offer investor protections. Overall, putting the above two points together this looks like a liquidity issue rather than a solvency problem.

AI fears indiscriminately impacting software companies

Software and technology services represent a meaningful share of direct‑lending portfolios (20%+). Concerns around margin pressure and AI‑driven disruption have been cited as contributors to investor caution, particularly within BDC portfolios. This does appear to have created significant uncertainty short-term and stimulated redemptions.

AI is no doubt a challenge for software businesses and some companies will be disrupted and become obsolete because of it. As we have seen in stock markets, a mood of sell-now-ask-questions-later has prevailed However, we believe many of these businesses will prosper and so the indiscriminate nature of the AI concerns does appear overdone, particularly as the impact of AI will likely play out over several years not quarters. As noted above, credit loans are high in the capital structure and supported by high levels of equity which takes losses first, providing a buffer for credit investors.

Private Equity links need to be monitored

Private Credit is tightly linked to Private Equity through sponsor leverage. A sustained rise in defaults or tighter underwriting would raise financing costs, reduce leverage multiples and slow deal activity, but current evidence suggests stress is sector specific rather than systemic. The market is being tested but remains functional.

KPRIME portfolio exposure is limited

With respect to the KKR Private markets fund (KPRIME) there is no private credit exposure held in the portfolio. The portfolio is well diversified with over 125 individual positions held. Direct lending used to help fund portfolio companies is limited to the 7% exposure to mid-market private equity deals. Across the portfolio deals are largely funded through an average 50% equity, with debt provided via bank syndications. KPRIMEs software exposure totals 15% of assets and is focused on high-moat businesses where AI strengthens competitive advantages rather than disrupts them. We continue to believe the portfolio is well positioned in the current environment to deliver on its objectives.

Early stress not systemic risk

Recent stresses in private credit should not be dismissed lightly but the situation remains early stage and contained. There are limited signs of rising defaults with problems appearing to be liquidity focused not solvency driven. This is not unusual for a market adjusting after a prolonged period of rapid growth.

Critically, private credit remains a small fraction of the US$130+ tn global bond market, making comparisons with the GFC misplaced. Pressure is highly concentrated by fund structure and sector. Default and non-accrual rates have edged higher, but from very low levels, pointing to pockets of stress rather than systemic repricing.

Private Credit’s close relationship with private equity warrants monitoring. Should redemptions persist and translate into valuation pressures and tighter lending markets, there could be knock on effects for Private Equity markets. In this environment, manager quality and portfolio diversification are critical. For now, evidence points to cyclical and selective stress not a systemic event.