By Andrew Bary

The private credit " cockroaches" may have finally arrived, and they're scurrying from the software sector. They may also have created opportunities in shares of business development companies that own the debt of the companies.

Few asset classes have been as popular as private credit -- or as controversial. The market totals over $1 trillion of loans made directly to riskier companies. The loans are then sold to institutional investors through non-publicly traded private credit funds, and to retail investors through publicly traded business development companies, or BDCs, like Ares Capital, Blue Owl Capital, and FS KKR Capital, as well as semiliquid private funds like Blackstone Private Credit and Apollo Debt Solutions. The funds have big payouts juiced by financial leverage, and in good times appear to carry little risk.

But times could be changing. JPMorgan Chase CEO Jamie Dimon warned last year about "cockroaches" in private credit markets after two auto-related blowups last year. The culprit this time, however, has been the sharp decline in publicly traded software stocks, which are now down an average of 20% this year. The typical private-credit fund invests about a fifth of its money in the sector, according to a recent report from UBS, though the actual amount could be higher. Software's decline helped prompt a selloff in the $350 billion BDC market, with the VanEck BDC Income exchange-traded fund down 5% this past week and hitting a 52-week low. The BDC now yields 12%.

The concern is that if marquee, public software companies with strong balance sheets like Salesforce, ServiceNow, and Workday are getting hammered by concerns about artificial intelligence, what's the outlook for dozens of smaller, highly leveraged software companies?

All this is hitting stocks of alternative asset managers such as Blackstone, KKR, Apollo Global Management, Ares Management, and Blue Owl Capital, since private credit has been a big growth area for them. The private credit industry may now be facing one of its toughest tests since it came on the scene after the financial crisis.

Think of private credit as a private version of the junk bond market. Funds make loans to highly leveraged private companies generally valued at $5 billion or less that now carry high-single-digit to low-double-digit yields. The loans usually carry interest rates that adjust at a margin of four to six percentage points above short-term rates. The market is a private-equity financing mechanism, since most borrowers were taken private in leveraged buyouts.

It is also opaque, since the loans rarely trade and offer limited or no liquidity, and valuations are usually set by the fund manager. Borrower financial data is rarely available publicly. The appeal is that private credit can offer 10% yields on diversified portfolios, and historic loan quality has been strong with minimal losses. Management has mattered. Ares and Blackstone have better records than KKR and Goldman Sachs, based on their BDC credit quality.

The issue now is whether the trend of high yields and limited losses will continue, given how AI is disrupting software. Software companies have enticed private credit because of their active deal flow, high yields -- often above 10% -- and greater-than-usual asset coverage. But tech and software loans tend to have less traditional earnings and have riskier pay-in-kind structures than private credit loans to other sectors.

Barclays fixed-income analyst Peter Troisi highlighted the challenge of evaluating BDCs that report their net asset values quarterly. "At a higher level, it is nearly impossible to determine which software exposures at BDCs contain the highest latent risk because they are investments in private companies," he explains. More-liquid loans to bigger software companies in the broadly syndicated market, he notes, are down 3% to 4% in recent weeks.

Asset managers take a more benign view. Ares Capital, the largest BDC, was one of the first to report its fourth-quarter results. In a conference call this past week, CEO Kort Schnabel said portfolio quality is in "excellent shape," with nonaccrual loans around 1%. Blackstone President Jon Gray had a similar message in January on the firm's fourth-quarter earnings conference call.

Blue Owl Co-CEO Marc Lipschultz addressed private credit and software exposure on the asset-management company's conference call this past week. Blue Owl's stock has been hit hardest among its peers due to the firm's outsize private credit exposure. Lipschultz said technology "continues to be the most pristine among all our portfolios." He added that tech loans on average are about 30% of the value of companies doing the borrowing, providing "huge equity cushions."

Private credit carries other risks beyond software. Both public and private funds use leverage, amplifying potential downsides. BDCs generally use about a dollar of borrowing for every dollar of equity. Private fund leverage generally is somewhat lower. The leverage is much higher than comparable investments in closed-end junk bond funds like the BlackRock Corporate High Yield fund, which has 25 cents in debt for every dollar of equity.

Leverage can compound mistakes. BlackRock TCP Capital, a BDC, recently reported a 19% drop in its quarterly net asset value on Dec. 31 due to problems at six portfolio companies. That prompted a 20% drop in its stock price, and the shares now trade around $5, a nearly 30% discount to its NAV of $7. The portfolio's loss was much smaller, but the BDC's leverage turned an 8% drop in its total portfolio value into a drop in its NAV of more than twice that, Morningstar analyst Eric Jacobson calculated.

Investors can also pay a high price for the privilege of owning private credit. BDC and private-fund fees are steep, often running at 3% to 5% annually of net assets, with the Ares and Blue Owl BDCs at the high end of that range, Barron's calculates. These are considerably higher than comparable investments, such as closed-end bond, junk, and loan funds or leveraged-loan ETFs. The industry argues that leverage is appropriate given strong credit history and that fees need to be higher than on funds focused on public securities since more-intensive work is needed to evaluate private businesses. Another issue: Lower short-term rates are putting downward pressure on loan yields, which has prompted some BDC dividend cuts.

BDCs offer a window on investment sentiment because the stocks can trade at a premium or discount to NAV based on investor demand. Sentiment is now the worst since 2022, and with BDCs trading at big discounts to NAV, some of the risks may be mitigated.

Industry leader Ares Capital, which has generally traded at a premium, now trades around $19, a 5% discount to NAV, while Blackstone Secured Lending, which a year ago traded at a 15% premium, has swung to a nearly 10% discount. Overall, the average BDC now trades at a 20%-plus discount to its NAV, and many traded this past week at discounts of 25% or more, including such large funds as Blue Owl Capital, Blue Owl Technology Finance, and FS KKR Capital. The discounted prices mean investors can get current yields of 12% or more.

"There are not a lot of areas of the market where valuations are attractive, and this is one of them," says Julian Klymochko, the CEO of Accelerate, a Canadian firm focused on alternative investments. "The market is pricing in a significant amount of loan losses, and I don't think we will see that."

He cites deeply discounted BDCs like Morgan Stanley Direct Lending, Bain Capital Specialty Finance, and Nuveen Churchill Direct Lending, which trade at roughly 25% discounts to their NAV, with yields topping 13%. He adds that investors should favor BDCs like the Morgan Stanley and Nuveen funds, which focus on the highest-quality senior secured loans instead of those that own riskier subordinated debt and equity.

Private funds, however, are another story. They are bought and sold at their NAV, which means investors have to pay full price for what they can buy at a discount elsewhere. The industry may have made a mistake in creating both, since sustained drops in BDC stock prices create incentive for investors to sell a private fund for 100 cents on the dollar and buy a comparable one for 75 or 80 cents, often from the same manager. Withdrawals are usually capped at 5% of net portfolio assets a quarter, although that limit can be waived.

Investor redemptions from many private funds picked up in the December quarter and appears to have continued in the current quarter. Blackstone Private Credit's redemptions were 4.5% of the fund's shares, or about $2 billion, but the fund still had a net inflow of $1.2 billion in the fourth quarter. It's possible that stepped-up investor redemption requests could prompt private funds to limit redemptions -- as Blackstone's private real estate investment fund, Blackstone Real Estate Investment Trust, or BREIT, did in late 2022 and 2023.

Accelerate's Klymochko says he would "stay away" from private funds. The largest are Blackstone Private Credit, Blue Owl Credit Income, and Apollo Debt Solutions.

For investors comfortable with the risks in private credit, avoiding semiliquid private funds in favor of BDCs priced at big discounts makes sense.

You could even call it good business.

Write to Andrew Bary at andrewbary@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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February 06, 2026 16:13 ET (21:13 GMT)

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