The false promise of private credit

Private equity, and increasingly now private credit , portray themselves as a superior and more exclusive version of stock and bond markets. A curious artefact of financial services is that adding the word “private” in front of an asset class can magically convey the perception of higher returns. Like a Louis Vuitton handbag or Rolex watch, these returns are hard to access, only available to favoured institutions and high net worth individuals (HNWIs). The price of admission to a hot “private” fund can sometimes be a minimum investment as high as $1 million.

Yet private credit assets under management (AUM) have grown from less than $200 billion globally before the 2008 financial crisis to around $1.5 trillion during the covid pandemic and to $2.5 trillion today, according to the Bank for International Settlements (BIS).

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Much of this growth has been aided by post-2008 crisis regulation. Various reforms forced banks to fund their balance sheets with more equity, while giving favourable risk weightings to mortgages and government bonds. That penalised banks for holding corporate debt. Meanwhile, quantitative easing (QE), which suppressed the yield on government bonds and lowered discount rates, indirectly encouraged life assurers and pension funds to seek out higher-yielding assets. When sovereign bond yields plummeted, institutions with long-term liabilities could no longer generate sufficient returns on government debt to cover their obligations. So institutional asset allocators turned to the promise of private credit, in an attempt to capture a theoretical “illiquidity premium” – earning a higher return in exchange for locking up capital in assets that had no secondary market.

The post-crisis regulation was well-intentioned, but the seeds of the next financial crisis are often planted in the roots of the previous one. Banks take short-term liabilities – customer current accounts and overnight interbank funding – and lend it out for longer. This is known as maturity transformation. When private credit stepped into the vacuum created by banks’ reluctance to lend to corporates, it came with a seductive story. Funds raise money from the insurance and pension industry with decade-long time horizons, who believe that they are paying high fees and locking up their money in return for higher returns. This structure of long-term commitments funding long-term lending means there is no maturity transformation, and so no possibility of bank runs.

However, to expand the pool of available money, the private credit industry in the US invented business development companies (BDCs). These funds promised quarterly redemptions capped at 5% of net asset value (NAV). This re-introduced the liquidity mismatch that private credit claimed to eliminate as soon as nervous investors wanted to get their money out – which is what has happened over the past year.

The $82 billion Blackstone Private Credit Fund (known as BCRED) has seen redemption requests running at roughly 10% of the fund in both the last two quarters. BlackRock’s $27 billion HPS Corporate Lending Fund (HLEND) saw low-teens percentage redemption requests. Blue Owl Technology Income (OTIC), which has high exposure to software-as-a-service (SaaS) debt, has seen requests rise above 38% of shares.

BDCs are a relatively small area of private credit, representing under 15% of the $2.5 trillion market, according to the IMF (although that is still large in absolute terms at $400 billion). However, the BIS and the IMF point out that trends in BDCs provide an unusually clear “window” into the otherwise opaque disclosure coming from the sector. Indeed, one of the events that drew more attention to private credit last year was when Blue Owl tried unsuccessfully to ease its redemption problems in an unlisted BDC called OBDC II by merging it into a publicly traded BDC (OBDC) that was trading at a 20% discount to NAV. OBDC II investors revolted, as this would have resulted in an immediate mark down.

In theory, rising interest rates can be a positive for private credit funds, as they will earn higher returns on money they lend out. On the other hand, borrowers may struggle and funds suffer from bad debts as interest rates rise. The opacity of the sector means this is hard to quantify. Default rates reached 6.3% for private credit borrowers in the third quarter of 2026, according to ratings agency Fitch. That default rate is an order of magnitude higher than estimates from Houlihan Lokey, an investment bank that specialises in restructuring. It says the figure is less than 1% of outstanding principal, but 2.5% by borrower count. In other words, the numbers are skewed by smaller borrowers in distress. On the other hand, Pimco, the giant California-based investor with over $2 trillion AUM, suggests the default number is three times higher than Fitch’s number at 19%, based on analysis of $500 billion of assets held in retail BDCs.

The feedback loop between private equity, and private credit is another potential problem. While private equity has come to rely on private credit funds to finance the debt component of deals – rather than banks – the relationship is symbiotic and also functions in the opposite direction. Apollo, Blackstone and KKR realised the life-insurance sector was a rich source of “permanent capital” – that is, insurance money is genuinely long-term funding, unlike BDCs. Thus private-equity firms bought life assurers and have used policyholder premiums as a stable funding source for their own deals. Instead of buying government bonds, these insurers began funnelling money into their own private credit vehicles, which have lent to affiliates in the private equity industry.

Mark Walter’s Guggenheim Partners is a high-profile example. Long before he led a consortium to buy Chelsea FC after Roman Abramovich became a forced seller, Walter was using policyholder premiums to buy US sports teams: first the Los Angeles Dodgers (baseball) in 2012 and later the Los Angeles Lakers (basketball). This is now under scrutiny. Federal prosecutors in the US are investigating how tens of billions of dollars in private-credit portfolios were used to fund deals for these trophy assets. After receiving grand jury subpoenas, Delaware Life, an insurance company controlled by Walter, restated its disclosures to reveal that affiliated investments tied to other Walter entities comprised $17 billion (roughly 40% of invested assets), up from the previously reported $1.4 billion. Walter’s holding company TWG Global has denied wrongdoing. He faces a civil fraud case, but no criminal charges have been laid against him.

At this point, we should ponder whether the promise of private credit to produce higher returns in illiquid assets – including football clubs – is a mirage. The word “private” suggests an exclusivity, which helps to justify illiquid, opaque funds that charge high fees. These attributes are very attractive for fund firms. “A critical goal of the financial industry in 2026 is to invest more of people’s retirement savings in ‘private assets’, because it is still possible to charge fees on the order of 1% (or higher!) for private investments,” as Matt Levine of Bloomberg puts it.

There is the nub. All the analysis of long-term performance suggests there is one asset class with the best record when time horizons are measured in decades. This is public equities. Triumph of the Optimists: 101 Years of Global Investment Returns, by Elroy Dimson, Paul Marsh and Mike Staunton made this argument in 2002, but the advantages of equities have been increasingly well understood since the 1950s when George Ross Goobey switched the Imperial Tobacco pension fund from 2.5% consolidated annuities (“consols”) into 100% equity.

Ross Goobey argued that dividends were likely to grow in-line with GDP and so equities were a safer asset class than gilts for investors with a long time horizon. Back in 1957, he quoted data from the Economist Intelligence Unit showing that £1 million invested in 1919 would have grown to £3.7 million if invested in gilts with proceeds reinvested, versus more than £28 million if invested in equities with dividends reinvested each year. His analysis proved prescient: 2.5% consols fell in value by 75% in real terms, while equities enjoyed a bull market from the 1950s until the secondary banking crisis of the mid-1970s.

Hence the institutional push into private credit ignores a fundamental and long-established truth of investment. For any investor or institutional fiduciary with a multi-decade horizon, equity ownership is the natural asset class because shareholders participate in compound economic growth. The push into private credit turns logic on its head. Lenders take asymmetric risk: they absorb full downside default losses without participating in any corporate equity upside.

Institutional asset allocators and HNWIs have forgotten this timeless message. Ironically, private credit funds have locked up investors’ money at a time when global stockmarkets, as measured by the MSCI World index, have increased in value more than seven-fold over the past 20 years in sterling terms with dividends reinvested, and have trebled in the last ten years. If amateur investors are pouring their money into global index trackers while sophisticated investors choose private credit funds, which of them is opting for the dumb money?

Private credit may nonetheless create opportunities for investors – just not in the illiquid, opaque, costly products the industry would like us to buy. Consider the disconnect between market narrative and balance-sheet reality in UK-listed life assurers such as Legal & General (LSE: LGEN), Aviva (LSE: AV) and Standard Life (LSE: SDLF) that has emerged due to private credit jitters. Equity investors have sold off the sector – pushing dividend yields up to 6% to 9% – yet much of this anxiety stems from conflating the UK framework with the US. The US lacks a federal life insurance regulator. All 50 states have their own regulator, hence it is Delaware that is investigating Mark Walter’s empire. The UK is closely overseen by one regulator.

Stress tests by ratings agency S&P have concluded that UK insurers – who hold illiquid assets (including private credit) as part of the assets backing their bulk-purchase annuity liabilities – hold sufficient capital to absorb a repeat of the 2008 financial crisis with an 11% default rate on illiquid holdings without breaching regulatory requirements. Note, too, that private credit accounts for only about 9% of UK life assurer portfolios and exposure is concentrated in long-dated, secured infrastructure and social housing rather than speculative leveraged buyout (LBO) loans. For investors with the stomach for risk, fears about the sector could represent a good time to buy.