Private Credit Hyperscalers Risk Eroding Investor Returns

Jeffrey Diehl Managing Partner & Head of Investments
Bill Sacher Partner & Head of Private Credit
Fred Chung Partner & Head of Credit Underwriting, Private Credit
 

Key Takeaways

• Large, publicly traded private credit managers have rapidly scaled business development companies and life insurance general accounts over the past decade, leading to rapid growth in assets under management and annual deployment
• Rapid asset scaling increases pressure on investment teams to deploy capital, which can compromise underwriting standards and credit selection. This can lead to sub-par returns, an underappreciated risk for institutional investors, the traditional source of capital for private credit managers
• The natural solution to address this risk is self-regulating asset growth. But publicly listed private credit managers have little incentive to do so given their stock prices are highly correlated to fee-earning asset growth

Institutional investors have long been the primary clients of private credit managers, investing through commingled funds and separate account structures (“SMAs”). In this capacity, they have regulated managers’ scaling ambitions – an important power, since we have observed that rapid asset growth and deployment scaling can often lead to an erosion of returns.¹

Today, this regulating power appears to have been diminished at some publicly traded private credit managers whose institutional assets have been dwarfed by rapidly growing wealth and insurance pools. These “hyperscalers” may be propelling their investors on an undetected ride of forced deployment, which we believe is likely to increase credit risk and erode returns.

Institutional investors would be well served to measure the total annual deployment growth of their private credit managers across all managed asset pools, assess manager alignment of interest with their investors, and conduct detailed portfolio reviews to spot camouflaged problem loans that may drive sub-par returns as outlined in our April 2025 article, Is Direct Lender Optimism Camouflaging Problem Loans?

Private Credit and Institutional Investors

Around the turn of the century, private credit managers emerged as competitors to traditional banks in extending senior debt for sponsor-backed buyout transactions. They raised money from institutional investors in traditional commingled drawdown funds. Those who succeeded in generating attractive returns sought to raise larger successor funds, increasing their deployment pace as well as their pool of management and performance fees. To raise a larger fund, managers had to convince institutional investors they could scale their annual deployment pace without compromising credit quality and returns.

Our historical experience investing in private market funds has shown that one of the strongest negative correlations to replicating top-tier returns of a fund is the percentage increase in successor fund size.² We have observed that gradual fund size and deployment increases have been a more predictable path to success. Achieving top quartile returns is paramount, since manager performance dispersion in private markets is higher than nearly every other asset class, as noted in our prior article, Private Credit Manager Selection, the Devil is in the Diligence. Sophisticated institutional investors have historically served as an important regulator to manager scaling ambitions and the prospects for solid future returns.

Private Credit Managers Expand into Wealth with BDCs

Over the past decade, large publicly traded private credit managers have developed perpetually offered Business Development Companies (“BDCs”). These private credit funds are registered with the U.S. Securities and Exchange Commission (“SEC”) and are often designed to allow access to wealthy individual investors. Unlike limited-life, closed-end drawdown funds, BDCs are evergreen and open-ended. They continuously reinvest realized proceeds and remain open to new investors. Private credit managers typically co-invest BDCs alongside their institutional commingled drawdown funds and SMAs.

Investors in perpetually offered BDCs can typically purchase shares monthly and sell shares quarterly, subject to redemption gates imposed by the BDC’s board of directors. BDCs have become popular with wealthy investors and their financial advisors as they avoid many of the tax and cash management complexities of drawdown funds, generally allow investors to step into an immediate cash yield, and can provide liquidity if needed. Driven by these factors, non-traded perpetual BDCs of publicly listed private credit managers have grown dramatically. As of Q1 2025, these vehicles have amassed $128B of net assets with the largest six products from publicly listed firms representing 72% of the total.³

While drawdown funds have sophisticated institutional counterparties that help regulate fund size growth, BDCs generally lack this oversight – leaving managers solely responsible for self regulating their scaling. Unfortunately, publicly listed managers of BDCs have little economic incentive to self-regulate, as their fees, revenues, and stock prices are correlated to growing fee earning assets. As a result, some perpetually offered BDCs have become huge, creating material deployment pressure on investment teams.

BDC Scaling Challenges

Today, we estimate that the managers⁴ of the four largest perpetual BDCs must, on average, invest $23 billion annually to keep their funds fully invested, including target leverage and current annual net inflows.^5,6 This figure does not account for the institutional funds and SMAs these managers are investing alongside these BDCs. The largest private BDC, we estimate, must invest $43 billion a year,⁷ representing approximately 27% of the annual US direct lending market.⁸ At this percentage of the market, it can become challenging to produce top-quartile returns, and the risk of investing some capital in lower quality assets, which are more likely to generate median or worse returns, can become quite elevated.

For perspective, $23 billion of annual deployment would be like raising and investing a $35 billion drawdown fund – using 1x asset-based leverage – every three years. This is materially larger than the biggest ever commingled drawdown private credit fund.⁹

Private Credit Managers Add Scale Life Insurance Assets

Like BDCs, life insurance general accounts are quasi-permanent. Life insurers collect premiums from the annuities and policies they sell, invest those premiums over time, and make payouts upon death or policy termination. When new policy inflows equal terminations, the general account remains stable. When new policies exceed terminations, the general account grows.

General accounts have a recurring, regulated mandate to invest in long-duration, yield-generating, rated securities to match their liabilities and regulatory capital requirements. Most independent insurance companies do this through investment grade rated liquid debt. In response, private credit managers have developed structures that package private loans into collateralized vehicles, with approximately 75-80% of the structure receiving investment grade credit ratings. These private credit collateralized loan obligations (“CLOs”) typically offer higher yields per unit of capital charge than liquid rated securities.

Deployment pressure often leads to sub-par results—especially when managers chase scale instead of opportunity

Several publicly listed private credit managers have bought or partnered with life insurance companies, pivoting the general accounts to their rated private credit structures.¹⁰ The largest four life insurers owned by or partnered with a publicly traded private markets manager average roughly $190 billion of general account assets.¹¹ Most of these insurers are growing their assets at a healthy clip, both organically and via acquisition. Assuming most of this capital is invested in private CLOs with an average underlying loan term of four years, the top four firms must, on average, deploy $47 billion annually just to recycle realized proceeds. This ignores future growth in the general account and does not account for the BDCs, institutional commingled funds, and SMAs being invested alongside these general accounts.

An annual deployment target of $47 billion is roughly equivalent to raising and investing a $70 billion drawdown fund – using 1x asset-based leverage – every three years. That is nearly three times the size of the largest-ever commingled drawdown private credit fund.¹² The CEO of one publicly traded private credit manager recently said, “we trained ourselves to think we are limited by capital; maybe we are actually limited by investment opportunities.” At his recent annual meeting, Warren Buffett said, “we have $350B in cash and I would prefer to have $50B. But if you told me I need to deploy the excess in three years, I don’t think you will be happy with my results.” In our experience and his, deployment pressure often leads to sub-par results.

Compromised Underwriting

So, what happens when a private credit manager oversees a hyper-scaling BDC and/or life insurance book? It puts tremendous pressure on investment teams to scale deployment, which in turn can lead to pursuing larger deals and potentially compromising underwriting and selectivity.

We have observed an erosion of pricing and terms in large direct lending deals, which must compete against the less discerning broadly syndicated loan (“BSL”) market.¹³ Compared to deals that do not compete with BSLs, we have observed that these large loans typically have 50-100 basis points tighter spreads, 5-10 points higher loan-to-value (“LTV”) ratios, and over 1.0x higher leverage (debt/EBITDA) off more aggressively adjusted EBITDA. In addition, financial covenants are often absent, credit protections are generally weaker and some structures allow sponsors to carve out loan collateral and/or introduce new debt that is senior to the existing loan. In certain cases, borrowers are also allowed to elect to pay payment-in-kind (“PIK”) interest instead of cash interest, either at issuance or during the term of the loan. This election adds debt to the existing stack, often when a company is struggling to pay its cash interest, making PIK conversions a key risk investors should be aware of.

More concerning than making concessions on price and terms, we have seen several deployment-pressured firms compromise on the underlying quality of borrowers.¹⁴ This includes lending to companies with highly cyclical, concentrated, or declining revenues, limited end-market growth, fierce competitive market dynamics, or material risk of disruption from artificial intelligence (“AI”).

One credit rating agency recently coined the term ‘Selective Default” to describe situations in which lenders have allowed cash-to-PIK flips, amortization holidays, and maturity extensions without receiving adequate compensation

If hyper-scale lenders are making these accommodations, shouldn’t signs of stress – such as non-accruals or loan markdowns – show up in their loan book? They should. But as we noted in our recent article Is Direct Lender Optimism Camouflaging Problem Loans?, many BDCs may be camouflaging problem loans, whether driven by optimism, self-interest, or both.

An examination of the last eight quarters of large BDC SEC filings¹⁵ shows an erosion of credit quality, even without having visibility into underlying borrower financials. In addition, credit rating firms have been increasingly reporting on rising defaults, and the growing number of cash-to-PIK conversions and debt-for-equity swaps– which often simply delay defaults.¹⁶ One credit rating agency recently coined the term ‘Selective Default” to describe situations in which lenders have allowed cash-to-PIK flips, amortization holidays, and maturity extensions without receiving adequate compensation. Another credit rating agency reported that approximately 17% of private credit loans have interest coverage below 1x, meaning these companies can’t afford to pay their cash interest.¹⁷ We have also observed material growth in job postings for “debt restructuring specialists” at publicly traded private credit firms, another indication that hyperscalers have a growing volume of problem loans. Deployment pressure at the largest BDCs has also begun to create overlapping portfolios, typically in large loans that compete with the BSL market. So, if problems surface at large private credit loans, it could ripple through the portfolios of multiple large BDCs.

The natural solutions for easing deployment pressure are 1) closing a hyper-scale BDC to new investors or 2) investing insurance books with third party managers who have access to differentiated deal flow. Publicly traded hyperscalers have no incentive to do either because their stock prices are based on growth in fee-earning assets. In addition, if a private credit manager doesn’t accept and manage new BDC capital, competitors will. So hyperscale managers continue to take new money and pile pressure on investment teams to increase deployment.

Finally, hyperscale BDCs have yet to face a true market dislocation that could cause investor redemptions to exceed inflows. A similar dynamic played out over several quarters in a large private real estate investment trust, which required a sizable and costly capital infusion from an institutional investor to meet redemptions.¹⁸ Should BDCs encounter a similar problem, they may be forced to sell assets at discounted prices, potentially impacting valuations of similar assets in institutional funds.

It is time to assess whether you are exposed to a hyperscaler, potentially taking you on an undetected ride of forced deployment, which may increase credit risk and lead to eroding returns

It is critical for sophisticated institutional private credit investors and high-net-worth platforms to understand whether their manager is hyper-scaling a BDC or insurance book alongside their capital. How much total capital is the firm deploying annually in your strategy, and how has that figure evolved over time? Is the manager capacity-driven in their fundraising targets or is fundraising simply fueled by the natural growth pressures of being a public company? What percentage of investment professionals’ net worth is invested alongside you?

It is time to assess whether you are exposed to a hyperscaler, potentially taking you on an undetected ride of forced deployment, which may increase credit risk and lead to eroding returns. Institutional investors would be well served to closely track annual deployment growth by their private credit managers, assess manager economic alignment of interest with investors, and conduct detailed portfolio reviews to spot camouflaged problem loans that could impair performance.

Read More From Adams Street Partners

1. Above statements generally represent a mixture of (i) objective data attained through a variety of sources which are available upon request, as well as (ii) Adams Street analysis based on market observations, historical deal flow or other factors; provided, however, that there can be no guarantee that this represents a complete universe of relevant data. Statements made represent current views and opinions as of June 2025 and are subject to change.
2. Id
3. Source: Adams Street analysis of publicly available data from SEC filings, as of March 31, 2025
4. The four largest non-traded perpetual BDCs by assets as of March 31, 2025 included: (i) Blackstone Private Credit Fund (BCRED), (ii) Blue Owl Credit Income Corp (OCIC), (iii) Apollo Debt Solutions BDC (ADS), and (iv) HPS Corporate Lending Fund (HLEND). There can be no guarantee that analysis of other BDCs would have produced similar results.
5. Based on Adams Street analysis, assuming: (i) a four-year average loan term, (ii) target leverage of 1.0x, and (iii) growth in investable assets. Growth in investable assets is based on quarter-to-quarter change as measured through publicly available SEC filings. These assumptions were deemed to be in line, or conservatively measured as against common industry standards, but changes in such assumptions could impact stated results, potentially substantially.
6. Includes BDC data publicly available via the SEC’s Electronic Data Gathering, Analysis, and Retrieval (“EDGAR”) system. Most recent company information as of March 31, 2025.
7. See supra at note [5] regarding relevant assumptions
8. Source: Fitch Ratings, “U.S. Leveraged Finance Annual Manual 2025.” U.S. middle-market loan issuance in 2024 was estimated at approximately $160 billion
9. Source: Pitchbook. As of July 2025, the largest US focused commingled drawdown private credit fund is Oaktree Opportunities Fund XII, which closed at $16.0 billion
10. See e.g., InsuranceNewsNet, Private equity stake in life insurers draws new round of critical reports, published January 9, 2024
11. Based on Adams Street’s analysis, the four largest insurers we have determined to be partially or fully owned by publicly listed private credit firms include: (i) Athene, (ii) Global Atlantic, (iii) Fortitude Re; as well as (iv) a collection of life insurers including AIG, Everlake, and Resolution, with the members of such collection each associated with the same investment manager.
12. Source: Pitchbook. As of July 2025, the largest US focused commingled drawdown private credit fund is Oaktree Opportunities Fund XII, which closed at $16.0 billion
13. See supra at note [1]
14. Id
15. See supra at notes [4], [5], and [6] although for statements of comparison to earlier periods, Adams Street has reviewed historical information through March 31, 2025.
16. See e.g., Fitch Ratings, U.S. Private Credit Default Rate Rises to 5.7% in February 2025, published March 20, 2025. See also, S&P Global, BDC Assets Show the Prevalence of Payments-In-Kind Within Private Credit, published December 12, 2024.
17. See e.g., Fitch Ratings, Private Credit Middle Market Defaults Remain Elevated on Higher Rates, published May 39, 2025
18. See, e.g., Bloomberg, Blackstone’s BREIT gets $4 Billion California Injection, published January 3, 2023

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