Is private credit a bond market problem?

Negative headlines around private credit have intensified this year, driven by the AI-related software sell-off and the news that most players have restricted withdrawals from retail private credit funds.

This has become an increasing concern for investors in broader fixed income markets, who have seen spread widening seep into areas of public credit (corporate and financial bonds) at times this year when the fears around private credit have been most acute.

While there is certainly a risk of more contagion if we do see losses in private credit vehicles start to increase, there are important factors we believe will help keep public credit markets more resilient even if negative sentiment on private credit deepens.

Private credit is more than direct lending

Given the frequency of negative headlines around private credit, it is worth understanding the breadth of the asset class and which parts are drawing scrutiny.

Private credit covers a range of activities that involve non-bank lenders creating debt that is not sold publicly to investors. Globally the asset class is said to total around $3tr, with around half of this being “direct lending” – loans made to companies by asset managers and specialist private credit firms rather than banks.

Direct lending has experienced material growth in the last few years, driven partly by stricter regulation making certain types of corporate lending less attractive for banks, but it is only one part of the market. Infrastructure and commercial real estate projects are often financed via private credit, for example, while another significant part of the market is asset-backed finance – these are private securitisations that generate regular cashflows from a defined pool of assets rather than lending to companies themselves.

It is important to recognise that private credit is a vital source of funding for certain types of companies or assets, and it can also be well-suited to certain types of investors. For companies, financing is quicker and far more flexible when it is done on a bilateral basis rather than via a broadly syndicated bond deal, where terms must be standardised to appeal to a broader investment community. On the investor side, those with long-term liabilities such as insurance companies or pension funds can be a natural home for longer term, less liquid private credit investments that match their liabilities and tend to offer higher yields than the public bond markets.

Therefore, it is extremely inaccurate to say that the whole of private credit is “good” or “bad”, just as it would be to say that every government or company issuing bonds in the public markets is good or bad. However, there are of course private credit investors and originators that are better than others, and varying levels of leverage and risk management across the industry.

Three potential problems in private credit

Generally, the recent concerns around private credit are three-fold.

First, there are concerns that the explosive growth of the industry, and in particular direct lending, in recent years has driven down lending standards and asset quality as lenders competed for market share. Since private credit assets are not traded on public markets, an additional concern here is that some lenders’ own valuations of the assets they hold may not be a true reflection of expected default or recovery rates.

Second, there are concerns around liquidity mismatches in certain private credit vehicles. Some of the rapid growth in private credit’s assets under management has come from retail investors – chiefly high net worth individuals – attracted by the potential high returns on offer. Given the more illiquid nature of their assets, private credit funds offer investors liquidity on a periodic (usually quarterly) basis and have redemption limits in place; the concern is that these liquidity management mechanisms may not have been fully understood by some retail investors if they moved quickly into private credit in search of higher returns.

Third, there are concerns around the growing participation of insurance companies in private credit. While private credit can be a perfectly sensible allocation for insurers, many large private capital firms, especially in the US, have either acquired life insurers or have partnerships that involve managing their investment portfolios, which some view as a problem if insurers are being directed to invest in private credit assets originated by their owners or affiliates.

Software exposure is the pain point for private credit

These well-documented issues aside, the chief source of pressure on private credit in recent months has been the industry’s heavy lending to software-as-a-service (SaaS) companies.

The SaaS sector suffered a sharp sell-off in early February as markets digested the threat posed by “agentic” AI tools from the likes of Anthropic, hitting software stocks and bonds and fuelling redemption requests in private credit.

Wealthy investors attempted to pull $20.8bn from private credit funds in the first quarter of 2026, according to the Financial Times, based on funds tracked by the FT that collectively manage around $300bn. Blue Owl, Blackstone and BlackRock were among a number of firms to limit withdrawals from private credit funds in Q1 as investor redemption requests increased.

The negative sentiment has also been reflected in the sliding share prices of US Business Development Companies (BDCs), which are listed SEC-registered vehicles that have become a popular route into private credit for retail investors.

As Exhibit 1 shows, BDC exposure to the software sector is generally much higher than in public (broadly syndicated) credit markets such as leveraged loans, collateralised loan obligations (CLOs) and high yield bonds. Share prices have also been hit by BDCs cutting their dividends, partly due to weaker asset allocations but also as a result of falling cashflows from so-called payment-in-kind (PIK) loans which allow companies to add interest payments to the principal amount instead of paying in cash.

Software exposure calculations vary, since they are compiled by working through BDC investor presentations and categorising the holdings. JP Morgan, for example, estimates BDC software exposure to be 18%, much lower than the Morgan Stanley estimate shown in Exhibit. Individual BDC exposures can obviously vary widely, from as low as 2% in some vehicles to as much as 50% in smaller, tech-focused names; the MS estimate is based on a wider cohort of BDCs, which includes more of the latter. As usual, it is crucial for investors to look under the hood of private credit vehicles and perform the proper analysis, to avoid making generalised assumptions.

Could private credit pressure get worse?

While the general concerns around private credit, such as the transparency and accuracy of asset valuations, are perfectly valid, it is worth acknowledging that away from the SaaS sector we are not seeing general pressure in other segments of the economy.

Therefore, we see no reason to believe private credit will see bigger problems than other asset classes when it comes to well-performing sectors; as we said earlier, there are many good private credit managers out there lending to good businesses.

The jury is still out on whether there is more pain to come for the SaaS sector given the threat of AI disruption, but if there is, then we would certainly expect private credit operators (especially in direct lending) to be heavily impacted.

Obviously, Saas assets in bank lending and public credit markets such as loan and bonds carry similar risk, but in general the software exposure in these lending channels is much lower.

It is worth noting here that heavy withdrawals from private credit funds do not necessarily mean we are about to see a wave of defaults in the space. Some portion of these redemptions will be pre-emptive – i.e., investors who read the first headline about the “gating” of one private credit fund may have decided to request redemptions across their holdings knowing that further restrictions were likely.

In addition, with many BDCs now trading at steep discounts to net asset value, it is likely that at least some of the redemptions from unlisted private credit funds are being driven by investors looking to opportunistically switch their exposure into BDCs to take advantage of the lower valuations.

Contagion risk is real, but fundamentals remain robust

For diversified fixed income investors, the key question in the private credit story is whether it has any read-across to the public credit markets where most of their funds will be allocated.

Clearly there is a risk of contagion, particularly for higher beta fixed income sectors, if the concerns around private credit become acute enough that investors sell first and ask questions later; we have seen evidence of this already this year when the software sell-off sparked some widening in corporate bond spreads and CLOs. Should concerns or losses in private credit become more severe, we would expect a read-across to public markets as investor anxiety increases.

More broadly, there is some risk of a funding squeeze if private credit lenders were to come under real pressure from SaaS defaults. This is a severe scenario, but again, private credit is an important funding channel for certain sectors of the economy, and if firms facing defaults in one sector were to cease lending in others, it is unclear if there would be lenders to pick up the slack, with potential implications for growth.

However, there are two important factors we believe will help to keep public credit markets somewhat insulated from further problems in private credit, beyond the lower SaaS exposure we described above.

The first is the general strength of credit fundamentals. As Exhibit 2 shows, across investment grade (IG) and high yield (HY), both in the US and Europe, earnings have shown little sign of deterioration in recent quarters and net leverage (a typical marker of late-cycle excess in credit) has also been notably stable.

The second is the positive technical backdrop that is supporting public credit markets, with high overall yields in fixed income meaning demand for the asset class continues to far outweigh supply. 

This is demonstrated by how active the primary market has been despite the volatility driven by the conflict in the Middle East. March 10 was a record day for US corporate bond sales, for example, while on March 24 HSBC was able to reopen the market for Additional Tier 1 (AT1) bonds – subordinated bank debt at the riskier end of the credit spectrum – with a $2.5bn deal that was eight-times oversubscribed, showing investors remain keen to put money to work.

Spotlight on CLOs

This technical dynamic is one of the reasons spreads in public credit have held in reasonably well year-to-date, despite the double whammy of AI and private credit headlines and the US-Israeli war with Iran.

As Exhibit 3 shows, across developed market IG and HY, spreads remain some distance from the 12-month highs they hit in the wake of the original US tariffs announcement in April 2025.

One area where spreads have widened more substantially, and we think some relative value has emerged, is European CLOs. We had reduced our exposure to lower rated CLO tranches earlier this year in favour of AAA notes, but now that BB spreads have widened to more attractive levels we are seeing some interesting opportunities here.

As a reminder, CLOs are securitisations backed by a portfolio of senior secured corporate loans that is actively managed by the CLO manager. Given their underlying collateral is corporate loans, CLOs were unsurprisingly one of the sectors to suffer some contagion from the fears around private credit. 

However, the corporate exposure investors take through CLOs is different to the corporate exposure they take through private credit.

CLOs are backed by broadly syndicated (and publicly traded) rather than privately originated loans, portfolios tend to be well diversified across sectors and geographies, and investors have complete transparency on every loan in the portfolio.

Most significantly, the securitised structure of CLOs, with junior tranches providing credit enhancement to more senior ones, offers bondholders considerable protection against any deterioration in performance of the underlying loans.

As Exhibit 4 shows, for an average BB European CLO tranche to suffer a principal loss (assuming a 60% recovery rate for loan defaults and a 10% constant repayment rate), it would take close to an 8% default rate in the loan pool every year, a cumulative default rate of 35% over the life of the deal. Since 2002, the annual default rate for global sub-IG CLOs has remained below 1% (for European CLOs issued post-2008 the rate is 0%) compared to a long-term average default rate of 4% for global high yield corporate bonds.

Tight spreads put focus on value

Given the volume of capital that has been deployed in private credit in recent years, it is a fair assumption that lending standards will have been weak in places, particularly among smaller players with a heavy focus on tech.

For fixed income investors, contagion is a valid concern if negative headlines keep coming and private credit vehicles begin to book real losses. However, we think public credit’s relatively lower software exposure, in addition to the general strength of fundamentals and technical demand for fixed income, should provide some insulation from any further deterioration in sentiment.

Given the muted spread widening we have seen across mainstream markets in response to both the software sell-off and the war in the Middle East, European CLOs and selectively US CLOs are one area where we can look to put money to work.