From the high-yield myth to liquidity crises, how many hidden risks are there in private equity capital?

The global private equity industry, holding $22 trillion in assets and operating outside the regulatory purview of banks, is facing its most severe stress test since the 2008 financial crisis. The myth of high returns is rapidly fading, and the shadow of a liquidity crisis looms.

According to the Financial Times, multiple “semi-liquid” private credit funds aimed at individual investors have triggered redemption limits and activated “gatekeeping” mechanisms to suspend withdrawals. Nearly $4 trillion in potentially overvalued private equity transactions are struggling to exit under high interest rates and geopolitical turmoil, with industry financing levels halved compared to the peak in 2021.

Alan Schwartz, Executive Chairman of Guggenheim Partners, stated candidly, “The foundations of the private debt market have begun to crack; any sell-off involving illiquid and opaque assets could cause severe shocks to financial markets.”

Andrew Bailey, Governor of the Bank of England, also expressed concern, stating that the “cutting and restructuring” of private credit loans has set off alarm bells, echoing the history of subprime mortgages being repackaged and sold globally before the 2008 mortgage crisis.

Industry leaders strongly refute the crisis comparisons, with Jon Gray, CEO of Blackstone, calling such comparisons “the most disconnected judgment from reality I have ever seen.”

However, as risk exposure spreads from pension funds and insurance companies to tens of thousands of ordinary savers, coupled with Trump allowing 401(k) retirement savings accounts to invest in private assets, the game between high return promises and liquidity realities is being passed on to an increasingly broad audience.

From Margins to Giants: The Rise of Private Equity

The growth of private equity has not happened overnight.

Decades ago, KKR founders Henry Kravis and George Roberts were merely a small deal team that started by acquiring stagnant corporate assets through cheap acquisitions, their ambitions limited only by the size of available bank credit at the time.

In the 1980s, Michael Milken’s Drexel Burnham Lambert popularized junk bonds and leveraged buyouts, providing the industry with the coveted credit ammunition. Drexel collapsed in 1990, but its former executives spread across Wall Street, founding significant firms like Apollo, Ares, and Cerberus.

The 2008 to 2010 financial crisis marked a true historical turning point for private equity.

As traditional banks withdrew from risky loans under regulatory constraints, private equity filled the gap, providing financing to companies with weaker credit profiles. Ultra-low interest rates suppressed financing costs, prompting pension funds and endowments to flock in search of higher returns, with some institutions raising their allocation to private assets to 30% of their portfolios.

Private credit thus grew into a $2 trillion market, with annualized returns close to 10% since 2004, and the market capitalization of some private equity groups even surpassing that of blue-chip investment banks like Goldman Sachs.

In 2021, the industry raised a record $1.2 trillion, with acquisition price multiples nearly doubling over the previous decade.

The sources of funds have also diversified—Asian real estate tycoons, wealthy American dentists, and even retired doctors from Provence, France, have become targets for firms like Blackstone, Apollo, Blue Owl, and Ares, collectively attracting over $200 billion.

Mathieu Chabran, co-founder of Tikehau Capital, realized after his father received a promotional brochure from Blackstone’s private debt fund that “the wealth and growth of giant U.S. management firms is increasingly sourced from retail channels,” and he worries that such funds are being mis-sold to inexperienced ordinary investors.

Banks and Insurance: The Hidden Transmission Network of Risk

The rise of private equity did not occur in a closed environment. The deep involvement of traditional banks and insurance companies has woven an invisible network of risk.

Banks have found that lending through private credit channels is more favorable in terms of capital regulation.

Michael Roberts, CEO of HSBC’s Corporate and Institutional Banking, explained before the UK’s Financial Services Regulatory Authority that loans to private credit secured by guarantees enjoy special regulatory treatment—banks may only need to hold 20% of the capital for this, while lending directly to the same borrower requires holding 100%.

According to Moody’s estimates through June 2025, the scale of loans from banks to the private credit industry has reached $300 billion, with an additional $285 billion lent to private equity funds.

The U.S. Treasury Department’s Financial Research Office estimates that the total exposure of banks and other lending institutions to private credit funds could be as high as $540 billion, although it also notes that “overall, the leverage risk remains limited.”

Insurance companies are similarly deeply involved.

In theory, the long-term commitments of life insurance and annuity companies to policyholders make them a natural fit for the long-duration assets of private credit.

However, regulators and some Wall Street executives have grown increasingly cautious. Apollo’s sale of a large volume of loans to its insurance company Athene, acquired in 2022, has raised questions about whether asset pricing and scrutiny are sufficient.

Some industry insiders have also expressed deep concern about the so-called “rating shopping” phenomenon—seeking higher ratings from smaller rating agencies than those from mainstream institutions. UBS Chairman Colm Kelleher warned last November that such phenomena could pose “systemic risks” to the global financial system.

Declining Returns and the “AI Minefield”

The promise of high returns in private equity is being gradually eroded by rising interest rates and geopolitical pressures.

Nearly $4 trillion in potentially overvalued transactions are trapped in a difficult exit situation, with industry financing levels down about half from their 2021 peak, leaving many mid-sized funds unable to complete new fundraising rounds.

According to hedge fund Davidson Kempner, about a quarter of private equity funds since 2015 have failed to meet the return threshold needed to trigger performance fees. More than 10% of private equity-owned companies are choosing to increase debt rather than repay interest in cash.

Software assets have become a disaster area.

Scott Goodwin, co-founder of credit investment firm Diameter Capital, pointed out that the “AI risk factor” brought by artificial intelligence affects more than half of the transactions financed by private equity investment and private credit over the past decade, covering software-related acquisitions in healthcare, financial services, and other professional services—accounting for about one-third of overall industry activity.

Beil expects that after the confirmation of first-quarter earnings reports, the software sector will face a wave of concentrated write-downs, which were precisely the “golden transactions of private equity in the past decade.”

On the debt side, KKR and BlackRock’s funds have made significant write-downs on several holdings, with investment tools that once easily outperformed high-yield bonds and other public market products now forced to reduce asset valuations.

Michael Patterson, a BlackRock executive, acknowledged in a letter to high-net-worth investors in its private credit fund this month that it is “a disconcerting time,” and there is “real, far-reaching uncertainty” about how artificial intelligence will reshape personal and economic landscapes.

Redemption Waves Impacting “Semi-Liquid” Funds

The decline in returns is rapidly translating into redemption pressures. Products known as “semi-liquid” funds allow investors to redeem no more than 5% of net assets each quarter, a design aimed at preventing forced low-price asset sales. However, as redemption limits are reached, several funds have activated “gatekeeping” mechanisms to restrict capital outflows.

Former Goldman Sachs CEO Lloyd Blankfein recently told the Financial Times that it has been a long time since the last major credit market crash, and liquidity mismatches are becoming increasingly likely. “Once a shock occurs, you will find a large number of assets continuing to be valued at prices that cannot be realized in the market,” he said.

Some American pension funds and university endowments have begun discounting private equity fund shares on the secondary market and are starting to divest their credit portfolios.

Wealth advisor Patrick Dwyer (NewEdge Wealth) has advised clients to reduce their exposure to acquisition funds, bluntly stating that funds raised before 2022 are “done”—he believes that private equity firms have expanded too quickly, attracted too much capital, and are being forced to invest in increasingly lower-quality deals, making a reckoning inevitable.

Regulatory Alarms and Industry Rebuttals: Is This Time Really Different?

Regulatory warnings are becoming increasingly frequent.

Andrew Bailey pointed out that the way private credit loans are handled has “disturbing echoes” of the history before the 2008 subprime mortgage crisis. The Bank of England will conduct targeted stress tests on related risk spillover scenarios this year, focusing on the industry’s lack of transparency, weak risk management, and its deep connections with the banking system.

Terry Monis, co-CIO of ICG Advisors, also raised the question: “Will the pain banks experience in commercial development companies and private credit force them to shrink risk in other areas?”

However, private equity industry leaders strongly disagree with the comparisons to systemic crises.

Jon Gray pointed out that the leverage multiples of private funds are typically only 1 to 2 times (with some funds exceeding 3 times), far lower than banks’ leverage levels of about 15 times; the lock-up periods for private equity are longer, unlike bank deposits that can be withdrawn overnight. He added, “There will indeed be defaults, and we see some companies facing challenges, but we are not in a recession… how this adds incremental risk to the financial system, no one has explained to me clearly.”

Alan Schwartz took a more moderate stance: he acknowledged that there are extreme behaviors in the market but stated that he “does not believe the depth and breadth of the impact is comparable to 2008”—despite the fact that Bear Stearns, which he led at the time, was one of the triggers of that crisis.

Diverging Outlooks: Integration or Liquidation?

Industry insiders tend to compare this round of pressure to the digestion process of the original private equity bubble in the 1980s.

The crisis at that time ultimately did not cause fundamental damage to the financial system, and some institutions that are still active today started by buying junk bonds at low prices from distressed insurance companies and pension funds. This time, several giants, including Apollo, have accumulated sufficient war reserves, ready to look for opportunities in the difficulties of their peers.

However, Dwyer predicts that private equity will face a “liquidation day”: institutions will be forced to push their portfolio companies to go public, even if that means investors must endure impairment losses. Private equity-owned companies also face the risk of technological disruption brought about by AI, and he expects the default rate among companies will rise as a result. “There’s too much money, everyone has become greedy, and they’ve killed the goose that lays the golden eggs,” he said.

A deeper concern lies in the continuation of trends.

Trump’s allowance for 401(k) retirement savings accounts to invest in private assets means that the “retailization” process is difficult to reverse—this implies that more ordinary savers, who do not fully understand liquidity risks, will be brought into this system.

As Mathieu Chabran stated, the gap in ability and information between ordinary retirees and Asian sovereign wealth funds when evaluating the same investment is essentially unbridgeable. The next stress test for private equity may just be beginning.

Risk Warning and Disclaimer

        The market has risks; investment requires caution. This article does not constitute personal investment advice and does not consider the specific investment objectives, financial conditions, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article align with their specific circumstances. Investing based on this is at one's own risk.