Private debt faces its first real test as interest rates remain high. The asset class enjoyed what Jonathan Gray, president of alternative-asset giant Blackstone, called a “golden moment” in 2023, when the rapid post-pandemic rise in borrowing costs made direct lending newly attractive to institutional investors. But with sovereign yields rising sharply and interest rates expected to stay elevated for longer, cracks have begun to appear. Last summer, a number of US business development companies (BDCs) saw a surge in investors seeking to redeem their holdings, forcing some funds to cap redemptions to avoid a disorderly rush for the exits. The question now is whether this marks the beginning of a more difficult phase – or even a reckoning for an asset class that has experienced explosive growth.
Current challenges: higher rates, slower growth and redemption pressure
A more challenging macroeconomic environment is raising the risks for private debt. Slower growth, persistent inflation and the prospect of rates staying higher for longer are increasing the pressure on borrowers. The Bank of England’s system-wide exploratory scenario (SWES) exercise – a key indicator of heightened regulatory scrutiny – has specifically focused on the private markets ecosystem under stress, assuming a weak recovery with high interest rates and weak growth persisting. Globally, the Financial Stability Board is also increasing its focus on private credit, viewing it as part of the infrastructure of modern finance rather than merely an alternative asset class. In the UK, the Financial Conduct Authority is reviewing AIFMD reporting obligations, and the House of Lords published a report in January 2026 titled “Private markets: Unknown unknowns” that cited evidence on the growth of private credit and its regulatory implications. A UK parliamentary inquiry into the growth of private credit was launched in July 2025.
One immediate sign of stress has come from open-ended funds that invest in illiquid assets. When redemption requests rise, these funds can enter a vicious cycle: they sell their most liquid assets – often the best-quality holdings – to meet redemptions, and that news incentivises other investors to redeem too, lest they become the “bagholders” of the riskiest, least liquid assets. Some US BDCs were forced to cap redemptions last year, a move that hardly improves investor sentiment. Regulators are deeply concerned about liquidity mismatches where investors have regular redemption rights from fund structures while the underlying assets are highly illiquid.
What private debt actually is – and why the distinctions matter
Private debt is a broad label that covers several distinct activities: syndicated leveraged loans, direct lending, asset-backed finance and even fund financing. These differences are crucial. Syndicated loans are liquid and volatile but trade at tighter yield spreads, meaning they promise lower returns. Direct lending – where funds lend directly to borrowers – is illiquid and rarely marked to market. It is often presented as the core of “true” private debt because of its potential for higher risk-adjusted returns.
So far, that record has proved hard for institutional investors to ignore. Spreads of around 550 basis points over base rates remain appealing, while reported default rates are still modest. As a result, the asset class attracted large inflows from pension funds and insurers. According to private-markets data firm Preqin, assets could reach $2.8 trillion by 2028, up from $1.8 trillion currently. The research briefing provides additional context: the market is projected to reach approximately $4.5 trillion by 2030, effectively doubling current levels, with Preqin forecasting a compound annual growth rate of 9.88% from the end of 2023 to 2029, reaching $2.64 trillion. Fundraising in 2024 was down on 2023 due to a weak first quarter, but subsequent quarters saw a recovery. The European private credit market is experiencing substantial growth, with fundraising hitting a record €56 billion ($66 billion) in the first nine months of 2025. European funds accounted for 35% of global private debt fundraising in that period, up from about 24% in 2023 and 2024, and European private credit AUM is expected to double to just below €1 trillion by 2030. The UK, and London specifically, remains a key hub for European leveraged finance and private credit origination and structuring.
Hidden risks: AI threatens software businesses and concentration in portfolios
The most significant risk currently facing the private debt market is the hidden concentration of loan portfolios in the software and software-as-a-service (SaaS) sector – and the growing threat from artificial intelligence. A substantial share of private credit deals – estimated at between 20% and 35% of total direct loans – is exposed to software and SaaS businesses. These companies have traditionally been attractive to lenders because of their recurring revenues, predictable cash flows and healthy earnings before interest, tax, depreciation and amortisation (Ebitda) margins. However, the rise of AI is fundamentally threatening their business models.
Artificial intelligence may not disrupt these companies overnight, but it could gradually erode pricing power, compress margins and weaken exit valuations, making refinancing more difficult. The sell-off in software stocks between October 2025 and February 2026, combined with growing awareness of how exposed some lenders are to the sector, has highlighted hidden correlation risks in supposedly diversified portfolios. All lenders now have their eyes on Visma, the Norwegian business-software firm backed by Hg Capital. Visma has reportedly delayed its planned initial public offering – potentially until the latter half of 2026 or even 2027 – a decision that suggests growing caution among investors despite the company’s strong operations and cash generation. The delay is attributed to the AI-driven sell-off in the software sector, which has complicated market conditions for a large tech listing.
Jitters in private debt can be less publicly visible by definition, but the performance of HgCapital Trust, the specialist private-equity investor in software and services that has 13% of its portfolio in Visma, testifies to how sentiment has changed. It is now trading at a 25% discount to net asset value, having been on a premium in 2024. This concentration risk is particularly worrying because it is not immediately obvious: a portfolio may appear diversified across industries, but a significant share of deals in software and SaaS creates a hidden bet on a single sector. The research briefing notes that estimates suggest 20-25% of private credit deals are with SaaS companies.
Other risks further complicate the picture. The probability of default is growing, while recovery rates in private debt have never really been measured. Defaults can be obscured: the restructuring of US educational technology firm Anthology last year did not trigger a formal default, as its lenders allowed flexibility in payments. Payment-in-kind (PIK) – where interest is added to the loan principal to be paid at maturity – can similarly mask stress by deferring payments out of cash flow. The covenant-lite nature of some lending offers less protection than investors might expect, while recovery rates in restructurings may be weaker than for senior debt that requires regular cash repayments.
Valuations in private debt are also opaque and largely controlled by managers. However, as the asset class becomes more institutionalised, index providers such as S&P and Bloomberg are developing private credit benchmarks. BlackRock’s acquisition of Preqin in 2024 for £2.55 billion ($3.2 billion) in cash – a move intended to integrate Preqin’s data with BlackRock’s Aladdin platform – suggests that private markets will become more standardised and scrutinised, despite some fund managers fighting this trend.
Future outlook: market activity, dry powder and the real test ahead
Despite these challenges, the private debt market remains active. Although mergers and acquisitions activity in Europe slowed during the first quarter, two large refinancings drove solid deal volumes: TK Elevator (€1.8 billion) and Global Sports Group (€2.2 billion). The research briefing adds that CVC Capital Partners’ Global Sport Group underwent a significant refinancing involving KKR and Pimco, with a total financing package of approximately €3.7 billion ($4 billion). Ares Management and Apollo Global Management have also been active in sports financing. Debtwire notes that “the prominence of these large-cap deals also suggests direct lenders have successfully taken advantage of the volatility seen in Q1 to reclaim some market share from the syndicated markets.”
The amount of funds raised between 2022 and 2024 that are not yet invested – known in the industry as “dry powder” – will help maintain momentum. This dry powder will allow lenders to inject capital if needed and protect their initial investments, tempering the risk of a private-debt crisis. It will be used to address the “refinancing wall”: a large stock of debt raised during the low-rate era that now needs to be rolled over at significantly higher cost. So far, this has been managed through extensions and amendments – euphemistically renamed “Liability Management Exercises” (LMEs). Widespread defaults remain rare.
The appeal of direct lending persists. It can offer 100 to 500 basis points of additional yield over what is available in the traditional syndicated loan market, depending on the amount of leverage used by the vehicle or whether it acquires subordinated debt and junior capital. Combined with the ability to negotiate better structural protections than broadly syndicated loans, this yield advantage should continue to attract strong interest.
Regional differences matter. The US market is more mature and increasingly competitive as banks re-enter leveraged finance, encouraged by the Trump administration’s new regulations. In Europe, private debt is still expanding, supported by a more fragmented banking system and structurally lower penetration. The public markets tend to treat private credit as a homogeneous bet on leveraged buyouts, but outcomes will depend less on the asset class itself and more on managers’ capabilities: origination, underwriting discipline and balance-sheet flexibility. Scale is an advantage in stressed environments. Large managers such as Ares, Apollo and Blackstone have the ability to amend loans, provide follow-on capital and manage restructurings internally. Origination is the real moat, because it separates lenders that focus on financing commoditised leveraged buyouts – which are often syndicated loans – from those that source bilateral or semi-bilateral deals with pricing power and better protections.
Collateralised loan obligations – securities backed by a pool of loans, often from leveraged buyouts – have held up so far and offer diversified exposure to leveraged loans. However, their lack of control over the underlying loans, and consequently over the outcomes when borrowers come under pressure, may become more apparent as the cycle turns.
High-performing private-debt funds generally require high minimum commitments – institutional size, perhaps €2 million to €5 million for a fund such as CVI with strong exposure to central Europe. Some managers are starting to target individual investors as a source of further capital, but one should always be aware that individuals are less likely to get the best opportunities. Products offered by private banks where layers of fees accumulate should be avoided.
More interesting are listed funds and managers exposed to the sector. Some merit caution, but fears of a crisis may create buying opportunities in the best ones. In Europe, there is Tikehau Capital (Paris: TKO), which has robust exposure to special situations; ICG (LSE: ICG); and CVC Income & Growth (LSE: CVCG). In the US, Ares Management (NYSE: ARES) and Blackstone (NYSE: BX) have developed the strongest platforms in terms of origination. Apollo Global Management (NYSE: APO) has the strongest exposure to direct lending, but readers may prefer to wait for the dust to settle.
The easy part – the “golden moment” of rising rates without the accompanying stresses – is over. Higher rates are now a source of strain. As refinancing pressures build and dispersion rises, returns will be less a function of a rising tide lifting the whole asset class and more driven by selection, discipline, structure and scale. A broad opportunity is turning into a more challenging game.
