When it comes to private credit, 'some caution is reasonable,' advisor says. What to know

• Default rates in direct lending are expected to rise to 8% from 5.6%, driven primarily by AI disruption in software companies which represent 26% of private credit exposure
• The private credit market has tripled from $500 billion to $1.7 trillion over the past decade, with 80% of investors being institutional rather than retail
• High redemption requests in semi-liquid funds are partly attributed to profit-taking after three years of outperformance, as yields have fallen since 2022 while the premium over public debt markets has been cut in half

Private Credit Market Shows Pockets of Weakness, But Systemic Crisis Unlikely

Key Developments

The $1.7 trillion private credit market is experiencing selective stress, particularly in semi-liquid funds facing elevated redemption requests, though financial advisors maintain widespread trouble is "overstated." The sector has grown significantly from approximately $500 billion a decade ago.

Market Dynamics

Private credit funds, which make direct loans to companies at higher interest rates due to illiquidity and risk, have seen their appeal diminish as the yield premium over public debt has been cut in half since 2022 when interest rates peaked. This compression is driving some investors to take profits after three years of strong performance.

Defaults in direct lending deals are projected to rise to 8% from the current 5.6%, according to Morgan Stanley research. The increase is concentrated in software and AI-adjacent sectors, which represent approximately 26% of direct lending exposure. Industry disruption from artificial intelligence is the primary driver of expected defaults.

Investment Considerations

Financial advisors recommend limiting private credit exposure to no more than 5% of overall portfolios. Crystal Cox of Wealthspire Advisors characterizes current pressure as reflecting "a shift from a young, high-return market to a more competitive, mature one where manager selection and underwriting discipline matter a lot more."

Retail access remains limited, with 80% of investors being institutional. However, options include ETFs, business development companies (BDCs), and semi-liquid interval funds. President Trump issued an executive order last August aimed at expanding 401(k) access to alternative investments, with Labor Department proposals pending.

The consensus: selective caution is warranted, particularly regarding software-heavy portfolios, but systemic crisis fears appear overblown.