Private Credit’s Liquidity Squeeze Puts Lenders in a Tight Spot

It’s crunch time for private credit. Redemption requests from investors in retail-focused private credit funds have reached an all-time high and show little sign of abating, as liquidity jitters continue to ripple through the $1.9 trillion debt market.

Until the past couple of months, private credit had been the hottest private asset class in the global capital markets for the fast-growing universe of mass-affluent and high-net-worth individuals. Now the industry is staring down a reversal of fortune and gearing up for a high-stakes stress test of its ability to stave off a widening liquidity crunch.

Fund managers have been hit with elevated—and growing—demands from investors to cash out of fund vehicles considered “semi-liquid” through withdrawals typically offered each quarter and capped at 5% of fund value. Suddenly, the industry’s vaunted courtship of individual investors, who have fueled historic capital inflows, is facing its biggest reckoning to date as scrutiny mounts and new fund subscriptions decline.

“The feature, or the bug, of these things is you can’t get out right away,” said Matthew Malone, head of investment management at Opto Investments, a private-market platform for investment advisers. “Because of that, the client is getting reminded every quarter or month that this thing is still not resolved.”

Industry experts and wealth advisors are watching to see how private lenders weather the pileup of investor redemptions, and how investors react. Citing previous cases in which private funds saw high withdrawal rates, several said it could take well over a year for investors to get their money back, which could hurt new inflows and spur more individuals to rush for the exit. Moreover, some observers worry that a wave of loans could flood the market, as some managers may be forced to sell assets to raise capital to meet liquidity demands.

The varying responses underscore the potential misalignment inherent in selling institutional-style, relatively illiquid strategies to individual investors, many of whom are more fickle about locking up their capital long term. Fund managers essentially face a dilemma: They can relax liquidity caps to satisfy individual investors, which may compromise the longer-term value of their portfolio, or they can hold the line and “gate” redemptions, which may alienate investors and send a worrying signal about the fund’s underlying strength. This kind of backlash ensued in late 2022, when withdrawals were capped at Blackstone’s BX Real Estate Income Trust, its non-traded vehicle.

Hold Tight or Act Swiftly?

Managers have reacted to the current surge in redemptions with markedly differing approaches. Some, such as Blue Owl’s OWL tech-focused OTIC fund, took the unusual step of buying back shares worth more than 15% of the fund’s net asset value, far exceeding the usual 5% cap on quarterly cashouts.

Some have stood firm on their liquidity limits, which are designed to maximize manager discipline around long-term performance targets. In the latest instance, last week, BlackRock BLK capped withdrawals from one of its flagship credit funds at 5% after being hit with requests amounting to over 9% of its value. It was the first time requests topped the 5% level since the fund went on the market four years ago.

In a letter to investors, BlackRock said the 5.0% withdrawal limit is “foundational” to the 10.7% annualized net return that HLEND, a roughly $26 billion non-traded business development company, has achieved since inception. “Without it, there would be a structural mismatch between investor capital and the expected duration of the private credit loans in which HLEND invests.”

By contrast, Blackstone chose a novel course last week when its BDC, known as BCRED, faced $1.7 billion of withdrawals in the latest quarter, above the firm’s 7% limit. Rather than limiting redemptions, Blackstone injected $400 million into the fund, with its own executives chipping in personal capital, which in effect brought the redemptions within the 7% cap and allowed it to honor all the cashout requests.

Sun Setting On a Golden Age

In recent years, income-seeking wealthy individuals flocked to debt funds in response to their relatively high yields. Private lenders’ retail-focused funds have been a hit with affluent clients because they offer institutional-like market exposure in exchange for more affordable fees and periodic liquidity windows.

Private credit fund managers globally hauled in $1.3 trillion of new capital from 2021 through last year, according to PitchBook data—much of that via evergreen funds amassed through the wealth channel. But that bonanza is grinding to a halt amid a wave of investors seeking to pull their money out.

The upsurge of redemptions has come with a sharp selloff in shares of blue-chip alternative asset managers. It has heightened public scrutiny of opaque, relatively illiquid fund vehicles. And it has served up a stark reminder of how dramatically sentiment can sour against fund managers when investors are racing to sell back their shares. And that may be only the beginning of the fallout.

The growing tumult over liquidity management has raised the specter of a long-term financial blow to the private capital industry and its high-stakes bet on giving public investors access to hard-to-price, hard-to-trade asset classes like private debt, private equity, and real estate.

However, some investors take a more sanguine view. Overall, the private credit asset class remains healthy, with little sign of distress in underlying loans, according to Don Calcagni, chief investment officer of Mercer Advisors, a wealth manager with client assets of $96 billion. Calcagni says the current turmoil may stem from investors misunderstanding the fund structures they signed up for, rather than fundamental problems with the asset class.

Executives from firms like Blue Owl insisted there are no “red flags” in the portfolio of a fund that the company is winding down.

At Blackstone, President and CEO Jonathan Gray defended the overall health of his firm’s debt holdings and called the market’s concerns about redemptions “a ton of noise.”

Comments like these have largely gone unheeded as many financial advisers seek to pull back their clients’ money, and stock prices of asset managers have tumbled. “The industry has lost control of the narrative,” says Mark Goldberg, an independent advisor to firms in the alternatives industry and former CEO of Griffin Capital, which was acquired by Apollo Global Management in 2022.

A fuller picture is about to come into focus. Fund managers’ redemption windows will expire in the next week or so, providing a clearer view into the severity of cashout pressures and how managers will respond.

According to Goldberg, private lenders have already entered a “prolonged” cycle of negative net outflows, which could last up to two years as fund managers sort through the fallout of high redemptions. During that time, he predicts that cash balances will decline, new subscriptions will slow down, and liquidity options will dwindle. Goldberg estimates that by the second or third quarter this year, more than 80% of debt-focused semi-liquid funds will see net capital outflows, forcing some managers to “shrink their balance sheets by letting loans run off or selling loans.”

Traditional private funds that are illiquid by design can ride out market volatility and hold their loans to maturity. But distressed semi-liquid funds, which have the burden of periodic withdrawals, cannot sit tight. “That is the clear and present danger facing the industry,” Goldberg says.