Private markets face a new reality

After a decade of cheap debt, the rapid rise in interest rates since 2022 has fundamentally changed the game for leveraged private investments. For private equity buyouts, the cost of debt financing has soared, directly constraining deal volume and internal rates of return. Buyout funds can no longer count on low borrowing costs to boost equity gains, and many highly leveraged portfolio companies are now struggling with debt service. This higher-rate, slower-growth environment has slashed the efficacy of “financial engineering”: most recent PE returns came from valuation multiple expansion, but that tailwind is disappearing. Managers are being forced to rely more on genuine revenue growth and operational improvements to drive performance. The more expensive debt is also contributing to rising distress; indeed, the number of private-equity-backed bankruptcies hit historic highs in 2024, underscoring the strain on overleveraged deals.

For private credit lenders, rising base rates initially promised higher yields, but they also carry new risks. Many direct lending funds thrived when interest rates were near zero, yet today’s high-rate climate tests borrowers’ ability to repay. Leading investors have cautioned that intense competition in private credit has started compressing spreads even as default risks loom in a downturn. Singapore’s GIC, for example, warned that private credit’s rapid ascent comes with limited historical default experience and thinner premiums. In short, while private credit has boomed as banks pulled back, higher borrowing costs could expose cracks in underwriting standards and borrower resilience.

Valuations and lagged markdowns

A hallmark concern in private markets is the lag in valuation markdowns compared to public markets. Private equity portfolios did not adjust downward as quickly during the 2022 public market sell-off, which left many assets potentially overvalued on paper. Now, as those holdings eventually reprice or struggle to grow into prior valuations, investors face muted returns. In fact, a significant share of private assets from the last cycle have seen little to no appreciation: More than one-third of PE assets held for six years or more are now worth the same or less than their purchase price. These stagnant or declining values have dragged down performance metrics across the industry. PitchBook data shows that private equity’s annualized IRR fell below 10% in the year to March 2024 – a stark drop from the ~25% annual returns the industry used to target.

This valuation overhang means many funds are only slowly writing down assets, creating a risk of further “catch-up” corrections. The “NAV staleness” also contributed to the so-called denominator effect in 2022, as private holdings appeared to hold their value while public equities sank. The subsequent rebound in public markets in 2023 then left private marks lagging behind. Notably, 2023 saw a dramatic performance divergence: private equity portfolios barely broke even (roughly 0.8% return) whereas the S&P 500 rallied about 17.5%. This reversal – after 2022’s unrealistically smooth PE returns – suggests that private valuations are now coming back down to earth, underperforming public markets in the process. Such underperformance and valuation lags raise hard questions for investors about the true risk-adjusted value of private equity, net of fees and illiquidity.

Liquidity constraints and recycling risks

Liquidity remains the central pain point in private markets. After the dealmaking frenzy of 2020–2021, investors now face a very different reality: distributions are scarce, capital calls continue, and a vast backlog of unsold assets is clogging portfolios. PitchBook reports that in 2025 the ratio of investments to exits has climbed to roughly 3.1 to 1, the widest gap in more than a decade. This means that for every dollar of exit value being returned to investors, more than three dollars of new capital are still being put to work. A clear sign that liquidity is not keeping pace.

The numbers underscore the strain. Ernst & Young estimates that by mid-2025, private equity firms are sitting on around 30’000 portfolio companies, representing some USD 3 trillion in value, and that more than a third of these holdings have been kept for six years or longer. With exit windows limited, many general partners are even prepared to accept valuation discounts of 5-10% simply to achieve liquidity. While global exits rebounded somewhat in early 2025, with USD 302 billion realized in Q1, the strongest opening quarter since late 2021 according to HarbourVest, this remains a fraction of the USD 4 trillion in buyout value still locked up.

To plug the gap, managers have leaned heavily on continuation funds and GP-led secondary transactions, which accounted for over 40% of secondary market deal volume in 2024. These vehicles provide optional liquidity for existing investors but also highlight how difficult traditional IPOs and trade sales have become. On the investor side, some limited partners have taken more drastic measures: Yale University’s endowment, for example, moved to sell nearly USD 3 billion of private equity stakes in 2025 to raise cash, even at discounts. Such high-profile secondary sales show that illiquidity risk has shifted from a theoretical concern to a pressing reality.

More recently, the private markets industry has gone a step further by using evergreen and semi-liquid structures not only to broaden access but also as a mechanism to recycle hard-to-exit investments. With traditional exit routes still constrained, sponsors have been rolling aging or underperforming portfolio companies into newer vehicles they manage, often while raising fresh money from wealth management clients. Banks have eagerly packaged these products as exclusive opportunities for affluent investors, but regulators and industry insiders warn that the reality is more precarious. Evergreen funds, by design, promise periodic redemptions against assets that are fundamentally illiquid, and there is a risk that private banking clients become the marginal late-cycle buyers, effectively providing the exit liquidity for professionals who are de-risking. As one founder cautioned, retail investors risk being “saddled with the worst assets” when these transfers occur. What is presented as democratization of access could, in practice, leave wealth clients holding the least attractive parts of the private market cycle.

Private credit boom and emerging risks

Private credit deserves special focus, as it straddles the line between opportunity and concern in this new environment. In the wake of banks retrenching from certain lending (post-2008 regulations and during COVID), private credit funds surged to fill the gap, raising huge sums from both institutions and individuals. Notably, affluent individual investors in the US have poured money into private credit at record levels – about USD 48 billion in the first half of 2025 alone, already more than the entire 2023 total. These flows put private credit fundraising on pace to exceed the prior peak of USD 83 billion set in 2024. In Europe, too, assets in open-ended “evergreen” private debt funds doubled year-on-year to EUR 24 billion by mid-2025. The inflows from high-net-worth and mass-affluent investors have become so important that analysts at Moody’s describe individual investors as “one of the biggest new growth frontiers” for the industry. In short, even as some big institutions pull back, private credit has found fresh demand from yield-hungry wealth clients, business development companies, and other non-traditional sources.

However, the private credit boom carries its own risks. For one, the flood of capital can lead to weaker lending standards and lower yields. As mentioned, top investors like GIC have voiced alarm that private credit deals are being done at spreads that may not adequately compensate for risk. The market has grown so fast (roughly doubling in size over four years) that a significant economic downturn has yet to truly test how these mostly middle-market borrowers hold up. Unlike broadly syndicated loans or bonds, many private credit loans are illiquid and lightly traded, so repricing of risk can be delayed. Default rates in private credit could spike from historically low levels if higher interest costs and a slowing economy squeeze borrowers’ cash flows. Moreover, if many investors in private credit are newer entrants, they may be less prepared for potential liquidity gates or markdowns should loan performance deteriorate. The key concern is that private credit, often hailed as a safer, secured asset class, has not been through a full default cycle at its current scale. A rise in corporate distress could reveal how much of that USD 1 trillion market was priced for perfection.

Rethinking the illiquidity premium

A growing point of debate is whether private equity’s vaunted outperformance of public equities will hold up in this changing landscape. Recent data suggests that it has not. As noted, in 2023 the broad public equity indices handily beat the average private equity fund performance (17% vs ~1%). This came after a peculiar 2022 in which private equity returns stayed positive (+21% by one estimate) despite public markets falling, essentially an illusion created by valuation lags. Over a longer horizon, private equity still shows a premium over public stocks, but that premium is narrowing. Once fees, illiquidity, and survivorship bias are accounted for, the risk-adjusted returns of private equity have come under scrutiny. PitchBook’s figures indicate sub-10% recent IRRs for PE, which, given that U.S. Treasury bills have yielded around 5% recently, means the excess return for locking up capital and taking on leverage risk is slimmer than before.

Institutional allocators and sophisticated family offices are increasingly asking if the “illiquidity premium” is sufficient. The S&P 500’s strong rebound and the availability of 5–6% yields in high-grade bonds provide viable alternatives to new private fund commitments. Furthermore, private equity returns tend to be smooth until suddenly they are not. This can give a false sense of security in volatile times, only to disappoint later. Some investors are therefore recalibrating expectations, viewing private equity more as a long-term diversifier and active management play rather than a guaranteed alpha generator over public benchmarks. In private credit, too, the performance relative to liquid high-yield bonds or leveraged loans will be watched closely. If private credit can continue delivering mid-to-high single digit yields with low volatility, it will justify itself. But if defaults erode returns, investors might question paying hefty fees for what could be replicable with public debt instruments or direct bond portfolios.

Late to the cycle

Private equity and private credit are entering a more sobering phase. The assumptions that powered the last decade (cheap leverage, easy exits, ever-rising valuations, and abundant institutional demand) are no longer secure. Rising rates, lagged markdowns, constrained liquidity, and allocation fatigue have already eroded performance relative to public markets. For many sophisticated allocators, the once-promised illiquidity premium now looks slimmer, particularly against the backdrop of a resurgent S&P 500 and high single-digit yields in liquid fixed income.

The most disquieting development is the shift of distribution toward wealth management clients. By repackaging private funds into semi-liquid vehicles and evergreen structures, banks are offering access at precisely the moment when institutional investors are selling secondaries, slowing commitments, or demanding liquidity. Regulators and market commentators warn that this democratization risks turning private clients into the marginal late-cycle buyers. The ones left holding overstretched or illiquid assets when professionals have already begun to exit.

This does not mean private markets are irrelevant. They remain important sources of capital formation and potential long-term value. But investors, whether institutions or high-net-worth individuals, must approach them with a more critical lens. Manager selection, transparency of valuations, alignment of incentives, and liquidity planning are paramount. Above all, investors must resist the narrative that private equity or private credit are a one-way ticket to superior returns. In today’s environment, the illiquidity premium must be earned, not assumed, and access does not guarantee advantage.

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