For years, private credit was the Golden Child of the alternative investment world. It offered higher yields, marketed lower volatility, and pitched a sense of security that public markets couldn’t match. But as the tide goes out, a structural flaw is being exposed: the liquidity mismatch.
Given the continued strong reported performance, many private credit funds are now trading at a premium compared to public market equivalents of similar strategies. On paper, this appears to be a strength. In practice, this elevated pricing, combined with quarterly redemptions hitting caps, is creating a rush for the exits that presents a challenge for even the best-run private credit solutions.
The Valuation Gap: A One-Way Trade
The problem starts with “marks.” Public markets reprice in real-time. As investor sentiment toward less-liquid, higher-risk loans has soured, publicly traded prices drop instantly.
Private credit, however, moves slowly. When private marks remain elevated while public equivalents are cheaper, a perceived arbitrage opportunity emerges.
Investors realize that their “private” dollar is worth $1.00 inside the fund, but the “equivalent” assets in the public market are trading at $0.92. The rational move? Get out at par while you still can.
Game Theory: Everyone is Incentivized to Pull Out
This is where the Prisoner’s Dilemma of finance takes over. Most of these funds have a quarterly redemption cap, usually 5% to 7% of Net Asset Value (NAV).
In addition to the benefit of getting out at $1.00 when the fund is perceived to have a value of $0.92, if you believe that other investors are going to ask for their money back, you cannot afford to wait. If you wait, and the cap is hit, you are stuck in an increasingly illiquid vehicle with liquidity delivered at a premium NAV to others, leaving less for yourself. In addition, if you want a portion of your money back and redemptions are 2x oversubscribed, you are now incentivized to ask for 2x the redemptions you prefer just to get what you want.
The Individual Logic: “Even if I like the assets, I need to submit my redemption request now. If I’m first, I get 100 cents on the dollar. If I’m late, I may get less or be gated.”
The Collective Result: More investors submit a larger-than-needed withdrawal request. The fund may be overwhelmed, not because the underlying loans are “bad,” but because the exit door is too narrow for the crowd.
This is the “Theater Fire” scenario: The building isn’t necessarily burning, but because there is only one small exit, people may prefer to leave before a potential stampede.
The Three Doors: How Managers Respond
We have seen managers react in three main ways thus far, none of them particularly pleasant for investors.
1. Gating the Fund: The manager simply “closes the gate,” refusing to honor redemptions beyond the cap.
The Result: It stops the bleeding and prevents a fire sale, but it destroys investor trust and can lead to a “zombie fund” reputation.
2. Conversion to a Closed-End Fund (CEF): The manager converts the vehicle into a structure that trades on an exchange.
The Result: Investors get liquidity, but at a massive cost. CEFs can immediately trade at a 10–20% discount to NAV. You can leave, but you’ll pay a “liquidity cost” to do so.
3. Selling the “Crown Jewels”: To meet redemptions, the fund sells its underlying holdings.
The Danger: In a liquidity crisis, you can only sell what people want to buy. This means the fund sells its highest-quality, most liquid assets first.
The Bottom Line
The “Illiquidity Premium” that investors loved on the way up has become an “Illiquidity Penalty” on the way down. When the incentive structure rewards the first person to leave, the fundamentals of the underlying loans are almost irrelevant. The math of the exit takes over.
We should expect more gates, more CEF conversions, and a much more sober period for private credit. Managers who relied on high marks to keep investors happy may be forced into “down-rounds” or more permanent gates. For the investor, the focus will shift from chasing the highest yield to scrutinizing the “fine print” of the exit. In a world of capped redemptions, your greatest risk is sometimes not the borrower defaulting, but rather being the last person left in the room when the door is locked.
Disclosures
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward looking statements cannot be guaranteed.
This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.
Advisory services are offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2603-15.
