60% of the time, it works every time.
Anchorman: The Legend of Ron Burgundy (2004)
Executive Summary
Private credit’s roots were in serving smaller companies that banks often overlooked, but post-GFC growth and tighter bank regulation helped push the industry up market; in our view, that expansion may now be creating a renewed opportunity in the lower middle market where private credit originally built its edge.
Private credit is not monolithic right now. The broad story is less about an asset class in crisis and more about a market moving from easy expansion to a more selective, late-cycle environment.
The pressure points appear concentrated in three areas: strategy drift, software exposure, and liquidity mismatch in semi-liquid fund structures.
In our view, this is increasingly a market of dispersion. Manager underwriting, sector selection, and structure matter more than they did during the industry’s rapid growth phase.
Performance
Private credit has benefited from a long stretch of investor demand for income. More recently, performance appears to be diverging beneath the surface. There are widening differences across managers and strategies as higher rates, refinancing risk, and weaker credits begin to matter more. Said differently, this may be one of those moments when private credit still “works,” but not quite in the broad-brush way investors became accustomed to. From a portfolio perspective, that suggests results may depend less on the label and more on manager selection, underwriting quality, and structural discipline.
State of the Private Credit Market
Private credit’s growth over the last decade was built on a simple backdrop. Investors needed yield, banks pulled back from some lending channels, and private lenders stepped in with flexible capital. That basic demand for non-bank financing still looks intact. What appears to be changing now is the market environment surrounding it.
In our view, the current setup looks less like a verdict on the entire asset class and more like a transition in the credit cycle. The tide is no longer lifting all boats. Instead, the market seems to be doing what markets eventually do, separating disciplined lenders from those that benefited from friendlier conditions. That is an important distinction for investors, because “state of the market” is a more useful frame than “case for” or “case against.”
The so what is that private credit may remain relevant, but outcomes are likely to become much more manager-specific from here.
How the Market Drifted Upstream
Private credit did not begin as a catch-all answer for corporate financing. In its earlier form, it was often focused on smaller companies that were too small, too specialized, or simply not economical for traditional banks to underwrite with much enthusiasm. The appeal was less about scale and more about flexibility. Borrowers could access tailored financing, and lenders could focus on relationships, structure, and underwriting in parts of the market that were not especially well served by larger institutions. That basic model still matters because it is where private credit originally built its edge.
Post GFC, that opportunity set expanded materially. As bank regulation tightened and leveraged lending faced greater scrutiny, more lending activity migrated toward nonbank channels, particularly for borrowers that did not fit neatly inside traditional bank appetites. Private credit grew into that gap, helped along by investor demand for income and by borrowers’ willingness to pay for speed, certainty, and customization. Over time, what began as a more targeted market serving middle-market borrowers became a much larger and more mainstream pool of capital.
In the last five or so years, however, growth itself appears to have changed the shape of the industry. As funds became larger, the need to deploy larger amounts of capital pushed many managers up market into bigger deals. The challenge is that larger funds often require larger borrowers, and larger borrowers tend to attract more competition, looser terms, and less room for lender selectivity. In our view, that migration left part of the Market private credit was originally built to serve somewhat less crowded and, potentially, more interesting again. The so what is that some of today’s more compelling opportunities may not be where private credit expanded most aggressively, but closer to where it started.
Underwriting Discipline and Strategy Drift
As capital flowed in, some managers moved up market into larger, more competitive deals, where leverage was higher, documentation was looser, and structural protections were thinner. In a benign environment, those compromises can be easy to overlook. In a tighter one, they tend to become more visible.
That matters because higher rates and slower growth do not just pressure borrowers. They also pressure underwriting assumptions that once looked reasonable. The conversation, in our view, is shifting from origination volume to credit selection, workout experience, and the ability to protect capital when a loan does not go exactly according to plan. Or, to borrow from the quote, this is the stage where “works every time” starts to sound a little less scientific. The so what is that this may be a period when manager selection matters more than broad asset class labels.
Software Exposure
Another key fault line is software. Private credit has had meaningful exposure to the sector, in part because recurring revenue businesses long looked like attractive lending candidates and most software companies remain private. AI disruption now appears to be testing one of the core assumptions behind many of those loans, namely revenue durability.
If that is right, then recent volatility in software-heavy portfolios may say less about a broad macro default cycle and more about a sector-specific reset. Some businesses may adapt well. Others may find that valuations, margins, and refinancing options are not as forgiving as they once were. That kind of repricing can be uncomfortable, but it is not the same thing as systemic collapse.
For portfolios, the important point is that private credit is not insulated from technological change simply because the loans are private. Sector concentration still matters, and this episode is a reminder that even contractual cash flows depend on the underlying business remaining viable.
Liquidity Mismatch
The most visible stress point for many investors may be liquidity. Semi-liquid structures expanded access to private credit, but they also introduced a familiar tension. The underlying loans are not truly liquid, even if the fund wrapper offers periodic redemption windows. That works smoothly when inflows and repayments exceed redemptions. It becomes more complicated when investors head for the exit at the same time.
A core reason to allocate to private markets is the potential to earn an illiquidity premium. In other words, investors may be compensated for giving up daily access to their capital. The trouble is that “semi-liquid” can sound a lot like “liquid” when markets are calm, and a lot less like it when investors rush for the exits. That does not mean the structure failed. It means the structure is being understood in real time. In our view, today’s redemption pressure is a useful reminder that liquidity and return are usually a tradeoff, not a free add-on. For portfolios, that reinforces the need to match private market allocations with time horizons that can actually absorb temporary lockups.
The below table details several funds that have hit redemption caps or gated withdrawals. In our view, that does not necessarily mean the structures are broken. In many cases, the gates are functioning as designed. Still, it is a useful reminder that liquidity terms and portfolio liquidity are not the same thing.
Chart: Recent Redemption Requests vs. Fund Caps for Semi-Liquid Private Credit Funds
This may be the most literal example of the ‘60% of the time’ theme. Liquidity can feel available right up until it is rationed. The so what is that investors should treat fund structure as part of the investment thesis, not as a footnote.
Where Opportunity May Still Exist
If there is a relatively more constructive corner of the private credit market today, it may be the lower middle market. These borrowers are often too small for public debt markets and too small to be the primary focus of the industry’s largest lenders. That can create a part of the market where relationships, underwriting discipline, and structuring still carry real weight. In a period when scale has not always translated into selectivity, that distinction matters.
Many of these businesses are founder-led, privately held, and operating in more basic industries that do not rely on heroic assumptions to justify a loan. To be clear, smaller companies bring their own risks. They can be more exposed to economic softness and less diversified than larger issuers. But in our view, the tradeoff is that lenders may have more ability to negotiate stronger covenants, maintain tighter documentation, and focus on businesses where cash flow visibility matters more than narrative momentum.
That is not a sweeping endorsement. It is simply to say that, as private credit becomes more differentiated, the lower middle market may be one area where specialization still offers a meaningful edge. The so what is that opportunity may still exist in narrower, less crowded parts of the market, but manager experience and underwriting discipline are doing more of the work.
Portfolio Takeaways
For investors, private credit still appears to have a role, but this looks like a period that calls for realism over romance. The market backdrop is exposing differences in underwriting, sector exposure, and liquidity design that were easier to gloss over when capital was abundant and defaults were low.
That argues for a diversified approach, patience around illiquidity, and discipline in manager selection. It also argues against treating any single private market exposure as a cure-all. In our view, portfolios are generally better served by balancing private credit alongside public equities, traditional fixed income, and other diversifying exposures, rather than expecting one sleeve to work every time. Over time, disciplined allocation and staying invested through volatility are likely to matter more than trying to react to every market headline.
Louis Tucci; Partner | Senior Investment Advisor
Paulo Aguilar, CFA, CAIA; Partner | Senior Investment Advisor
Mark H. Tucker, CFA; Chief Investment Officer
Chuck Bettinger; Portfolio Manager
Securities offered through Arkadios Capital. Member FINRA/SIPC. Advisory services through Arkadios Wealth.
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