The Rise of Private Credit: A Post-Crisis Phenomenon
The private credit market’s dramatic expansion is a direct consequence of the post-2008 regulatory environment. Following the Global Financial Crisis, stringent regulations such as Dodd-Frank in the U.S. and Basel III internationally compelled traditional banks to significantly reduce their exposure to riskier, often smaller and mid-sized corporate loans. These reforms aimed to strengthen bank balance sheets and prevent a recurrence of systemic collapse, but they inadvertently created a massive funding gap for a vital segment of the economy. Businesses that once relied on conventional bank financing found themselves struggling to secure capital, opening the door for non-bank lenders.
Private credit funds, offering direct lending solutions, stepped into this breach. They provided quicker decision-making, more flexible terms, and a more bespoke approach to financing than traditional banks could or would. This agility proved highly attractive to a diverse range of companies, from startups to established middle-market players, enabling them to fund operations, acquisitions, and growth initiatives. For investors, private credit offered compelling returns, often surpassing those available in conventional fixed-income markets, along with the allure of diversification and lower correlation to public markets. This symbiotic relationship fueled explosive growth, with the industry swelling to its current formidable size of $3.5 trillion.
Semi-Liquid Funds: The Fastest-Growing Segment Faces Scrutiny
Within this burgeoning landscape, semi-liquid private credit funds have emerged as the vanguard of growth. These funds, structured as business development companies (BDCs), operate by deploying capital into illiquid, long-term private loans while offering their investors limited quarterly liquidity through share redemptions. This "liquidity transformation" mechanism, designed to bridge the gap between illiquid underlying assets and investors’ desire for some access to their capital, has been a key driver of their popularity. Their assets under management have experienced what analysts describe as "hockey-stick growth," rocketing from a mere $10 billion in 2019 to an anticipated $300 billion by the end of 2025. This rapid ascent underscores their appeal but also highlights the scale of the potential vulnerabilities now coming to light.
A new paper, titled "The Fragility of Semi-Liquid Private Credit Funds," authored by Drexel University finance professor Chuck Fang and Wharton finance professors Itay Goldstein and Yao Zeng, meticulously details the systemic risks embedded within this model. The research, based on an extensive analysis of regulatory filing data from 52 semi-liquid BDCs spanning two and a half years from the first quarter of 2024 to the second quarter of 2026, posits that the industry is currently navigating a period of profound instability, reminiscent of the liquidity crises that have plagued other financial instruments in the past.
The AI Disruptor and the Emerging "Software Crisis"
A critical factor exacerbating the current stress is the seismic shift underway in the technology sector, particularly the disruptive impact of artificial intelligence. Software firms constitute a substantial portion of the loan portfolios held by semi-liquid private credit funds, representing a hefty fifth of their advanced capital. Many of these loans are extended to software-as-a-service (SaaS) companies, whose business models traditionally relied on recurring subscription revenues.
However, the advent of sophisticated, low-cost AI agents, particularly from late 2025 onwards, poses an existential threat to many SaaS providers. These AI agents are rapidly becoming capable of performing tasks previously handled by expensive software solutions, offering businesses unprecedented efficiency at a fraction of the cost. This technological revolution threatens to cannibalize the market for existing SaaS products, leading to reduced revenues, increased churn rates, and ultimately, a significant deterioration in the creditworthiness of software borrowers.
According to the paper, these impending technological disruptions have already led to "sharp revisions of the probability of default by borrowers," precipitating what the authors term a "software crisis" within the private credit sector. Business development companies, heavily exposed to these software companies, are consequently facing the daunting prospect of marking down the values of their illiquid loans, directly impacting their net asset values (NAVs) and overall financial health.
A Chronology of Mounting Redemption Pressures
The theoretical risks outlined by the academics are already manifesting in tangible redemption pressures across the industry. In recent months, numerous semi-liquid BDCs, including those sponsored by some of the biggest names in investment banking, have been confronted with unusually large redemption or unit repurchase requests.
For instance, the paper highlights how Blue Owl Capital Corp II and Blue Owl Credit Income Corp. faced redemption demands equivalent to nearly 22% and 40%, respectively, of their shares outstanding. These figures are alarmingly high, especially when considered against the typical quarterly redemption cap of 5% of a BDC’s shares outstanding. Other prominent private credit funds, managed by industry titans like Blackstone, BlackRock, and Apollo Global Management, have also reported repurchase requests that have exceeded this 5% threshold, indicating widespread investor unease and a scramble for liquidity.
These redemption pressures are not isolated incidents but represent an industry-wide phenomenon, reaching what the paper starkly warns are "run-like proportions." Professor Itay Goldstein articulates the inherent vulnerability: "The fact that every quarter people can take out 5% creates a self-fulfilling cycle, where if you think others are going to come and take the money out, you want to be there first." This psychological dynamic, where fear of being last to withdraw incentivizes rapid exits, is a classic hallmark of financial runs.
The comprehensive data analyzed in the paper reveals a concerning trend towards aggregate net outflows. In the second quarter of 2026, for the first time in their history, semi-liquid BDCs experienced net outflows, with repurchase outflows hitting $7.1 billion while new issuance inflows dwindled to $3.8 billion. Furthermore, a staggering $10.7 billion in redemption requests went unmet, or "gated," by the 5% cap. These gated requests do not disappear; they linger, reappearing in subsequent quarters and thus creating persistent and compounding redemption pressure. This reliance on fresh capital inflows to offset repurchases is, as the paper notes, "a fragile strategy," especially since new issuance tends to decline precisely when repurchase outflows surge, making liquidity least available when it’s most needed.
The Semi-Liquidity Trap: Structural Design Flaws
At the heart of the crisis lies a fundamental disconnect in the design of semi-liquid funds: the promise of limited liquidity for investors holding highly illiquid, long-term private loans. The 5% quarterly redemption cap, intended as a safeguard, is proving insufficient because many funds simply cannot generate enough cash from new share issuances or their existing reserves to honor even these capped withdrawals.
The paper meticulously dissects the mechanisms through which these funds typically generate liquidity and demonstrates their inadequacy:
- Cash Buffers: Semi-liquid BDCs maintain an average cash holding of only 5.5% of total net assets (TNA). Given recurring 5% quarterly redemption possibilities, these buffers are quickly exhausted.
- Net Investment Income: The net investment income derived from their loan portfolios averages just 2.5% of TNA each quarter. This income is largely paid out as dividends, as BDCs, like other registered investment companies, must distribute at least 90% of their investment income to qualify for pass-through tax treatment, further limiting retained earnings for liquidity.
- Maturing Loans: Income from maturing loans is also severely limited, averaging less than 0.5% of TNA per quarter.
When these conventional sources fall short, funds are forced to resort to more costly and destructive measures.
Challenges in Loan Sales and NAV Staleness
Liquidating their underlying loans by selling them to other asset managers presents significant hurdles. The vast majority of these loans—around 80% on average—are unrated and inherently illiquid. They are not traded on public exchanges, and their ownership is often concentrated, with less than 20% held by 10 or more distinct fund families. Attempting to sell such assets under pressure invariably triggers "fire-sale discounts," meaning the funds would have to sell at significantly reduced prices, turning a liquidity crunch into a value destruction event.
This illiquidity also creates a problem with Net Asset Values (NAVs). The fair values of these loans may adjust slowly due to the absence of active markets and the costs associated with liquidation, leading to reported NAVs that are "stale or inflated." In such scenarios, redeeming investors can effectively exit at a price above the true economic value of the underlying portfolio, transferring the difference as a loss to the remaining investors. This dynamic creates a powerful incentive for investors to redeem early, especially when negative news makes the true value of assets questionable, fueling a "first-mover advantage" mentality. As Professor Yao Zeng warns, "If there are a lot of investors redeeming and that’s going to lead to liquidation of loans and higher leverage going forward, it means investors will expect lower returns."
The Leverage-Redemption Doom Loop
When other options are exhausted, semi-liquid BDCs often resort to borrowing from banks. However, this comes at a steep price, typically higher interest rates due to the perceived risk. The paper illustrates that an increase in net outflows equivalent to one percentage point of TNA is associated with a 0.38 percentage point increase in net debt issuance, meaning BDCs increase their debt-to-asset ratio precisely when they face outflows.
This behavior, the authors contend, traps semi-liquid BDCs in a "leverage-redemption doom loop." Funds experiencing larger redemptions receive weaker new issuance, are compelled to sell illiquid loans at discounts, borrow more, and delay payments to redeeming investors through "repurchases payable" (effectively internal customer debt). These actions impose liquidation and leverage costs on the remaining investors, who then face the prospect of lower future returns and a weakened balance sheet. This higher leverage, in turn, further amplifies subsequent redemption incentives, creating a vicious feedback loop that is identified as "a key source of fragility in semi-liquid private credit funds."
The combined impact of loan liquidation, increased leverage, and NAV inflation significantly amplifies these "run-like redemptions." While some funds may rely on sponsors or long-horizon institutional investors for temporary liquidity support, such as Blackstone employees investing additional capital to meet redemption requests, these sources are discretionary and often not scalable, especially during broad-based market stress.
Broader Implications and Regulatory Oversight
The turmoil in semi-liquid private credit funds carries significant implications for various stakeholders, particularly as the U.S. Department of Labor (DoL) has actively encouraged broader access to alternative assets. In March 2026, following a presidential executive order in August 2025 aimed at "democratizing access to alternative assets for 401(k) investors," the DoL proposed a rule encouraging retirement fund managers of 401(k) and other defined-contribution plans to invest in alternative assets, including semi-liquid private credit funds.
The timing of this regulatory push, coinciding with the current market stress, has ignited a debate over the advisability of exposing retirement savers to the inherent risks of these funds. Professor Zeng emphasizes, "Our main message is that retail investors need to understand the true costs and risks of investing in semi-liquid private credit funds." The paper argues that expanding access to private markets is not merely a question of who can invest, but fundamentally "of how liquidity is promised, priced, and ultimately provided in stress."
The crisis also raises concerns about potential systemic risk transmission. The semi-liquidity provision in these funds’ business models "can transmit stress to private loan markets through asset sales and weaken future fund balance sheets through new debt borrowing and delayed payment obligations." This could have ripple effects, impacting the very small and mid-sized businesses that private credit was designed to support, and potentially even traditional banks that might have indirect exposures or lending relationships with these funds.
For regulators, the situation presents a complex challenge. The authors, while not making specific policy recommendations, highlight the shortcomings in the existing design and regulatory framework. Professor Goldstein acknowledges the difficulty: "It is an evolving space for semi-liquid funds, and regulators are on a treadmill, trying to catch up with the latest trend. It is difficult to always stay on top of the game."
The debate, Goldstein notes, has yet to produce an "optimal design" for semi-liquid funds that satisfies industry players, regulators, and academics alike. "There is demand from investors for liquid investments, even though the underlying assets are illiquid. We need a consensus on what is the optimal amount of liquidity transformation. And that’s very hard to get."
Possible regulatory responses could include moving these funds towards a closed-ended structure, dynamically adjusting redemption caps based on market conditions, or implementing stricter valuation practices and enhanced disclosure requirements regarding leverage and delayed-payment mechanisms. The core message from the academic paper is unequivocal: while redemption caps and periodic repurchase windows can limit immediate withdrawals, they do not by themselves eliminate the fundamental costs of transforming illiquid private assets into liquid investor claims.
As the private credit industry continues to mature and integrate further into the broader financial ecosystem, especially with increasing retail investor participation, all stakeholders—from fund managers and regulators to individual savers—must critically evaluate the true cost and inherent fragility of the semi-liquidity model. The current stress serves as a stark reminder that the promise of high returns in illiquid markets comes with significant, and often hidden, liquidity risks.
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