Amid the worst start to the year for their stocks in more than a decade, leaders of

Wall Street

’s biggest private markets firms had a surprising message: investors have reason to be concerned.

From Blue Owl Capital Inc. to Blackstone Inc.,

private credit

funds across the industry are facing a wave of withdrawals and analysts are warning default rates could soar if AI disrupts corporate America as much as some experts expect. And in private equity, managers are struggling to offload assets and return cash to investors, forcing them to turn to expensive forms of debt to extract returns from businesses they’ve acquired.

“People made choices: If you wanted a higher dividend, you could take more risk,”

Apollo Global Management Inc.

chief executive Marc Rowan said on stage at the Bloomberg Invest conference. “That felt really good on the way up. That’s not going to feel so good on the way down.”

Rowan was among a chorus of executives warning of the additional troubles to come for the industry at the conference on Tuesday. Soros Fund Management Chief Investment Officer Dawn Fitzpatrick said investors in both private credit and private equity are in for “a painful 18 to 24 months.”

And while Ares Management Corp.’s chief executive Mike Arougheti argued that a forecast last week from UBS Group AG analysts that private credit default rates could reach 15 per cent was “absolutely wrong,” he also said only those private markets firms that are more diversified will survive.

“Diversification is a big way to mitigate risks,” Arougheti said. “It’s also a way to dampen returns. We’re constantly trying to find that right balance.”

Some say turbulence is inevitable after years of rapid expansion.

“With any market that’s growing rapidly, there can be some level of a shakeout,” said Scott Adelson, chief executive officer of Houlihan Lokey, whose private credit database and analytical platform aggregates data from more than 60,000 loan valuations. “There are some credit providers that could have a difficult time.”

Problematic loans exist in both banks and in private credit, Adelson said in an interview Tuesday in Tokyo, noting that not every deal succeeds and that risk is what generate returns. Private credit as an asset class is “here to stay,” he added.

Brookfield Asset Management

chief executive Connor Teskey called the current challenges facing private credit “hiccups” for the industry — though he cautioned it wouldn’t diminish demand for such assets in the longer term.

“We generally are of the view that credit markets are in good shape, bank balance sheets are terrific, corporate balance sheets are strong, capital markets are liquid,” Teskey said. “Then you get to direct lending. And there are undoubtedly some concerns about direct lending.”

To gate or not to gate

The latest comments came as some asset managers faced a wave of redemption requests from investors — with many adopting differing approaches in how to deal with them.

Blackstone, for its part, announced on Monday it would allow investors to redeem a record 7.9 per cent of shares from its flagship private credit fund. On the other side of the spectrum, a Blue Owl fund said in recent weeks that it would halt quarterly redemptions and look to sell assets in order to return capital to investors.

Soros’ Fitzpatrick argued Blackstone’s move was smart for the long-term health of its business, arguing there would be a “culling of the alternative asset managers” who don’t hold up their end of the bargain when it comes to returning capital to investors as promised. But one of

Goldman Sachs Group Inc.

’s private credit chiefs argued limits on fund withdrawals are “features and not bugs” of the US$1.8 trillion market.

Such gating allows “the fund to actually protect the investor and the fund from the kind of value degradation that can happen in the context of fire sales,” said Vivek Bantwal, Goldman Sachs Asset Management’s global co-head of private credit.

It’s not just investors in the individual funds running scared. Shares of Apollo, Ares, Blackstone and KKR & Co. have all lost more than a quarter of their value this year compared with the 0.3% decline of the broader

S&P 500 Index.  

Much of the fears so far have focused on the risk that artificial intelligence poses to the software industry, which had been a favorite of private markets investors in recent years. With AI now threatening to eat away large parts of that business, the industry’s backers are worried defaults will rise.

A drop in valuations could also pose a new risk for some funds that have borrowed money from banks against their holdings, Fitzpatrick said. If lenders have to reassess the value of the loans that private credit firms have made, they could start demanding more collateral, she warned.

“Once they do that, those private credit funds are going to have to come up with cash to meet those margin calls,” she said. “If you start seeing pain or scrutiny on the banks on that lending side, I think that could be a harbinger of worse things to come.”

  • Caisse markets head says private credit concerns are overblown
  • Invico calls investors to manage exodus risk

While Ares’ Arougheti was adamant that UBS’ worst-case-scenario forecast for private credit default rates of as much as 15 per cent was overblown, he did note that some portfolios saw loss rates of eight per cent to 10 per cent during the 2008 financial crisis.

“If you’re talking about 15 per cent default rates in private credit, which again I think is not possible, but if you’re there, everything else in your portfolio, I assure you, is going to be completely torched,” he said.

With assistance from Rene Ismail, Olivia Fishlow, Ellen DiMauro, Kanoko Matsuyama and Takako Taniguchi

Bloomberg.com