What Can Investors Do If/When Private Credit Unwinds

At a recent hedge fund conference, which our team attended primarily to meet new managers, we also spoke with institutional allocators. We were surprised to hear both groups express a common concern: the potential “unwinding” of illiquid assets, particularly private credit.

While “unwind” is an imprecise term—implying anything from gradual performance erosion to a full-blown liquidity event—the consensus is that private markets are overextended. If stress emerges, private credit will likely falter first.

But asset classes rarely weather such crises in isolation. The severity of stress depends heavily on broader macro conditions. The investors and managers we met with suggested a base case of continued disinflation and declining interest rates, as well as markets with “fatter tails.” In other words, inflation to top off (even despite modest rate cuts) accompanied by episodic volatility: sudden credit spread widening, sharp equity drawdowns, and geopolitical shocks that disrupt otherwise slowing growth.

Falling Rates Don’t Always Benefit Borrowers

The view that private credit may stumble as rates decline appears contradictory at first glance. Since private credit loans are predominantly floating rate, falling base rates should theoretically improve debt-servicing by reducing interest expense.

It’s not always cause for celebration, however. If economic uncertainty rises and credit spreads widen, the reduction in base rates (such as SOFR) can be overwhelmed by higher risk premia. Borrowing costs can remain punishingly elevated even as headline rates fall. Furthermore, disinflation often coincides with slower nominal revenue growth. Companies facing weaker top-line expansion and margin pressure may struggle to refinance, particularly if they were underwritten at aggressive leverage multiples during more optimistic periods.

Chart 1: Borrower Leverage

Source: Federal Reserve

Solvency vs. Liquidity: The Two-Track Crisis

Private credit investors have a different lens than borrowers. Several allocators we spoke with said they have little problem with high base rates (e.g. SOFR) so long as those rates remain relatively stable and predictable. Volatility and uncertainty are different matters. To understand why, it helps to distinguish between two separate but related risks: solvency and liquidity.

Solvency Risk (the economy generally)

This is a fundamental credit disruption. Aggressive leverage and "spread shocks" overwhelm borrowers, leading to rising non-accruals and an increased reliance on Payment-in-Kind (PIK) interest.[1] This represents a "slow-motion" accident where companies "extend and pretend" because they cannot deleverage in the current regime. The solvency side of the problem is illustrated in part by Chart 1 above: The leverage among private-debt borrowers, especially in BDC-financed deals, has risen substantially over the last 10 years, leaving borrowers more exposed to spread shocks and refinancing stress.

Liquidity Risk (investors)

This is a structural failure of the fund vehicle itself – not so much a threat to the overall economy. It occurs when a confidence shock triggers a rush for the exit, particularly in "evergreen" or semi-liquid vehicles. PIKs also become more frequent, but the primary concern – given the illiquid nature of the underlying loans in the fund – is how funds can manage redemptions to prevent a fire sale.

Consider a simple example. If the market suddenly decides that a loan to a tech company should pay SOFR + 9% due to rising risk, but a private credit fund is holding an older loan paying only SOFR + 6%, the value of that asset has effectively declined. Yet because private loans are not traded daily, valuations may not immediately reflect that shift. Over time, such “stale” pricing can invite skepticism, eventually creating redemption pressure and liquidity constraints.

In practice, solvency issues and liquidity issues rarely move in tandem. Solvency stress tends to build quietly—through weakening earnings, rising leverage, and a growing reliance on tools such as PIK interest or amend-and-extend restructurings. Liquidity stress, by contrast, can appear almost overnight. Once investors begin questioning valuations or quality, confidence can shift quickly, and what began as a solvency question can rapidly become a liquidity story.

How Stress Might Emerge

Most industry participants envision a gradual deterioration rather than a sudden collapse. This includes increased use of PIK interest, "amend-and-extend" restructurings, and selective defaults emerging in weaker vintages. (Actually, some isolated borrower failures and restructurings have already begun to test investor confidence in the sector.) Private credit’s structural opacity complicates matters; if public markets reprice sharply while private valuations remain smooth, investors may begin questioning reported Net Asset Values (NAV).

This psychological shift can matter as much as fundamentals. Fitch’s U.S. Private Credit Default Rate rose from 4.6% in December 2024 to 5.8% by January 2026. Investors have taken some comfort in the fact that only a small portion of private loans have been reported as troubled (as measured, for example, by the share of loans no longer accruing interest). But more skeptical investors worry that problems may simply be surfacing slowly, with losses recognized on a lagging basis.

Recent volatility in publicly-listed credit managers highlights how quickly public markets can reprice perceived credit risk, even while private NAVs remain stable. Similarly, reports of record redemption requests draw attention to the tension between investor liquidity expectations and the illiquidity of the underlying loans.

When confidence erodes, a valuation story quickly becomes a liquidity story.

Adding potential fuel to the fire is the proliferation of private lending and private credit-related investments; industry group the Alternative Credit Council puts the global market at $3.5trn. A meaningful portion of private loans were originated during the pre-COVID period of elevated valuations and aggressive leverage so with exit markets slower and sponsor equity thinner in some transactions, the margin for error is narrower than in earlier cycles.

This risk could be further compounded by sector concentration – e.g. if most of these vintages were focused on the software/technology sector, or another narrow subcategory.

No, It (Probably) Will Not Be 2008

Some managers at the conference spoke in hushed tones about comparisons to the 2008 Global Financial Crisis (GFC). Such comparisons are common when discussing any type of credit crisis. The 2008 disruption was fundamentally a banking and payments-system collapse rooted in systemically critical institutions. A private credit downturn today would more likely resemble a "wealth and asset-price shock" than a collapse of financial plumbing.

The "tea leaves" point to more targeted historical episodes:

• The 1998 LTCM crisis and 2007 "quant quake," where crowded trades and leverage produced rapid but contained liquidity events.
• The rolling credit stress of 2002–2003 and 2015–2016, where deterioration unfolded in pockets rather than through systemic failure.
• The 2020 “dash for cash,” which demonstrated how quickly liquidity can evaporate even in public markets.

The common thread is not a total collapse, but episodic liquidity freezes and spread shocks. The consensus of seasoned investors is that a private credit unwind would be characterized by rising PIKs and non-accruals, wider credit spreads, weaker prices of listed business development companies (BDCs) and lender shares, and growing redemptions in semi-liquid (e.g. “evergreen”) funds, and stress in risk assets that stops short of a full banking-system event.

Implications for Alternative Investment Portfolios

If such an unwind with these features were to occur, the private credit investor would face both a problem and a potential opportunity. Private credit itself as an asset class is largely illiquid but remains elusive to more liquid hedge fund strategies (with the possible exception of those shorting the stock of listed private credit managers and BDCs).

But the consequences of credit stress rarely remain contained within private markets. They tend to surface in liquid markets through widening credit spreads, shifting interest-rate expectations, equity drawdowns, and rising cross-asset volatility. It is through these secondary effects—rather than direct effects—that liquid alternative strategies have historically found opportunity.

Investors and managers we spoke with also offered views on which strategies might benefit from the type of episode described above. The list below reflects not any single voice, but the aggregate consensus that emerged across those conversations. Still, no strategy is a universal hedge, and the historical analogs in Table 1 below are offered only as context.

Global Macro (Rates and FX Focused)

Macro strategies tend to thrive when central banks are shifting policy, fiscal paths are uncertain, and geopolitical tensions create divergence across countries and currencies. In a private credit stress scenario, yield curves could reprice, capital flows could shift abruptly, and policy responses could diverge. Such cross-asset and cross-border dislocations historically have created opportunity sets for skilled macro managers.

Notably, macro strategies do not require a market crash; they benefit from uncertainty and divergence. During episodic liquidity events like 1998 or 2020, discretionary macro has sometimes adapted quickly to early moves, while systematic approaches have often performed well once trends become persistent.

Trend-Following / Managed Futures

Trend-following strategies are designed to capture sustained moves across equities, bonds, currencies, and commodities — precisely the types of multi-month adjustments that tend to accompany credit repricing and regime shifts.

Recent performance challenges in certain fast-reversal environments have led some to question their crisis-hedging role. However, trend systems are not built to hedge single-day policy shocks. They tend to perform when dislocations persist and volatility clusters into durable trends.

Several experts suggested that in environments resembling 1998 or 2020, medium-term, diversified programs may be better positioned than either very short-term whipsaw-prone systems or ultra-long holding period approaches. Programs that dynamically adjust exposure and manage gross risk in volatility spikes may be structurally more resilient.

Tactical Short Exposure to Listed Financial Companies

Some managers pointed to a more direct expression of this theme: short exposure to publicly traded private credit managers and BDCs. Unlike private credit funds themselves, these vehicles trade daily and often react quickly when markets begin reassessing credit risk. Concerns about rising non-accruals, slower inflows, or widening spreads may be reflected in equity prices well before private loan valuations adjust.

That said, many investors cautioned that this “train may have already left the station” - as bearish moves tend to hit these stocks in the early stages of a credit repricing (public markets move faster than private markets) and, given the market cap losses of some BDCs in the past six months, some investors are now even contemplating whether there might be buying opportunities in the coming months.

Tactical (Long & Short) Commodities Exposure

Geopolitical instability and supply disruptions can create asymmetric commodity shocks, particularly in energy markets. But the consensus doesn’t seem to favor broad, long-only (beta) commodity exposure in a disinflationary backdrop.

Active or trend-driven commodity exposure may offer more flexibility, capturing episodic supply-driven moves without embedding persistent inflation beta. That said, some investors – funds-of-funds managers and multi-strategy managers in particular – forewarned that this should be seen as a more tactical tool. Commodity markets can reverse quickly as policy responses emerge, and inflation-linked exposure may underperform if disinflation dominates the broader macro regime. As such, this sleeve is often viewed as a targeted amplifier rather than a core diversifier.

Equity Market Neutral (Low- or Net-Short-Beta)

Seasoned allocators also cite the fact that late-cycle credit stress typically increases dispersion. Companies with fragile balance sheets or refinancing risk often underperform stronger peers. The idea is that low-beta equity market neutral strategies — those focused on stock selection rather than embedded market exposure — can potentially capture that widening gap.

The market-neutral evidence is less decisive than for macro or trend-following, in part because dispersion strategies depend heavily on manager style and timing. While the index we used, the Dow Jones Market Neutral Value Index, does not clearly support this, that could be because of the nature of the index – or the stage of the crisis we chose to focus on.

Table 1: Performance of Strategies during Previous Liquidity Crises

Source: Kettera Strategies. Past performance is not necessarily indicative of future results.

And we could not resist the temptation to also ask our fellow conference-goers about strategies where caution may be warranted, particularly if the goal is to escape from private credit stress. While we received a myriad of answers, the following two seemed to stand out:

Long-Biased Long/Short Equity (Net 40–60%)

In such an environment as outlined above, many investors said they’d be wary about meaningful net exposure here – as such strategies often behave as form of “moderated equity beta” during drawdowns. In volatility regime shifts, they may decline alongside public markets while offering limited convex protection.

Credit Long/Short and Yield-Oriented “Alternative” Credit

This is not private credit, rather this is credit/fixed income investing structured as hedge funds - with improved liquidity relative to private vehicles. But many credit long/short strategies remain structurally exposed to spread widening and liquidity contraction. In a late-cycle private credit environment, adding additional (inadvertent) credit beta may simply concentrate the same risk investors are attempting to diversify.

The natural non-alternative investment of course would seem to be U.S. Treasuries, which can still act as a classic safe haven in many credit episodes. Bonds often rally as markets price in weaker growth and potential future rate cuts. But the safe haven case is not airtight. Treasuries are less reliable when the shock is inflationary (e.g. driven by energy prices), and can also break down temporarily in 2020-style “dash for cash,” when investors liquidate whatever they can. Treasuries remain a useful defensive tool, albeit a more regime-dependent one.

And of course, the landscape can change after this credit “accident.”  The irony for the (currently illiquid) investor is that the eventual unwinding of legacy 2021–2022 vintages will likely birth opportunities for new private credit investors – possibly offering the widest spreads in a decade. But if an investor is locked or gated in yesterday’s deals, they may not be able to participate in tomorrows.

But this is yet another reason to turn to liquid, diversifying strategies now: To have a liquidity sleeve – featuring global macro and managed futures holdings - that bridges the "old money" crisis to the "new money" recovery.

Summary: A Rolling Re-Adjustment, Not a Sudden Collapse

The prevailing view among the firms we met with was not apocalyptic. Few predicted an imminent systemic breakdown. Instead, most described a gradual repricing process — a late-cycle adjustment in which leverage, underwriting standards, and liquidity mismatches are tested. In such a regime, volatility may be episodic but persistent, and policy responses are likely to be reactive rather than preemptive.

Private credit, in other words, is unlikely to “self-destruct.” If disinflation combines with slower growth and periodic shocks, any unwind would likely look less like 2008 and more like a series of rolling stress events.

For investors, the key takeaway is not to predict the precise timing of a crisis, but to recognize that the next phase may depend less on steady income and more on navigating regime shifts. In that environment, flexibility, liquidity, and true diversification may matter more than smooth marks, favoring strategies such as global macro, diversified trend-following, and low-beta equity market neutral over portfolios built mainly around yield capture.

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Jon L. Stein is CEO at Kettera Strategies

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The views expressed in this article are those of the author(s) and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group

[1] Payment-in-kind, or PIK, in the private credit context, is a mechanism allowing borrowers to pay interest, or a portion of it, by increasing the principal amount of the loan rather than paying interest in cash