Overview
The private credit market is encountering its first real stress after a prolonged period of rapid growth since the Great Financial Crisis. A series of high-profile defaults over the past 18 months coupled with a software selloff driven by artificial intelligence fears, and elevated investor redemption requests from private credit vehicles have led to increased scrutiny of the asset class by investors and regulators.
Tighter post-2008 regulations and capital constraints forced a retreat by traditional banks from middle-market corporate lending. Private capital providers took advantage of the subsequent vacuum created by offering flexible loan terms, quick closing, and deal close certainty. As interest rates rose, yield-seeking investors flocked to the private credit market to seek higher expected returns. By the end of 2025, industry estimates placed the US direct lending market at approximately $500 billion.
Current Situation
Despite the rapid expansion of private credit since the Great Financial Crisis, it still pales in comparison to broader US credit markets. Credit markets remain dominated by high yield bonds, investment grade corporates, and treasuries.
The software sector has long been a target of private equity with buyouts primarily financed by private and leveraged credit providers. The loans backing these buyouts are now facing heightened scrutiny due to rising AI disruption risks. These concerns likely contributed to increased redemption pressure.
Not all private credit markets are created equal. Software exposure varies widely depending on leveraged credit vehicle type. Business Development Companies (BDCs) average 26% exposure to software, while the overall US Leveraged Loan market features 14% and the high yield market just 5%. Not surprisingly, BDCs face the most obvious redemption pressure.
Since 3Q 2025, redemptions on average increased across the board and large funds are experiencing heightened levels of requested liquidity. After years of consistent positive net flows, BDCs experienced negative net flows during 1Q 2026. 2Q 2026 is expected to follow suit as investors continue to assess their private credit exposure.
Despite the noise, software company fundamentals remain strong. Default rates and distressed exchanges remain low. The vast majority of software companies are performing and adequately servicing their debt burdens. Of course, some of these businesses will be disrupted by AI or other factors. The current environment may distinguish managers that maintained disciplined underwriting standards from those that accepted greater credit risk.
Non-software sector fundamentals also remain solid. Default rates across sectors decreased since the end of 2023 after absorbing the Federal Reserve’s interest rate hiking period and remain below historical averages.
Our Position
Private credit investments have delivered outsized returns relative to public fixed income indexes over the past 15 years. Negative headlines within the private credit space are primarily tied to retail focused BDC vehicles experiencing material redemption requests and outflows. During this period of increased redemption activity, BDC vehicle structures are functioning as designed, utilizing liquidity management provisions to protect remaining investors’ capital.
The private credit asset class is experiencing a reset driven in part by AI replacement risk in the software sector and a subsequent pullback in capital flows from investors. Evaluating downside risks before investing and practicing prudent portfolio construction techniques may help safeguard investment portfolios from outsized negative results driven by any individual sector.
Disclosures
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Private investments are generally illiquid and long-term in nature. Investors should expect to hold such investments for extended periods, often 10 years or longer, with limited or no ability to sell, redeem, or otherwise access capital on demand. Secondary markets, where available, may be limited and may result in sales at prices below reported valuations. Capital may be called and invested over time at the discretion of the investment manager, and investors must maintain sufficient liquidity to meet capital commitments when due. Distributions are uncertain, depend on the performance and realization of underlying investments, and may be delayed by market conditions or other factors beyond the manager’s control. Reported valuations are estimates, may be based on subjective assumptions, and may differ materially from the values ultimately realized upon disposition. Private investments involve substantial risks, including the possible loss of some or all invested capital, and are suitable only for investors who can bear such risks and commit capital for extended periods.
Past performance is not indicative of future results. Given the inherent volatility of the securities markets, you should not assume that your investments will experience returns comparable to those shown in the analysis contained in this report. For example, market and economic conditions may change in the future producing materially different results than those shown included in the analysis contained in this report. Any comparison to an index is for comparative purposes only. An investment cannot be made directly into an index. Indices are unmanaged and do not reflect the deduction of advisory fees. Index definitions are available upon request.
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