Unlike private equity, where a long-held asset can have a late-stage turnaround, private credit loans operate differently. A loan that has not been refinanced after four years likely has underlying issues, as healthy companies typically refinance early. Therefore, a secondary portfolio of aged loans carries a high risk of adverse selection.

As private credit funds absorb riskier, smaller deals, the public high-yield market is left with larger, more stable companies. This migration has improved the overall quality and lowered default rates for public high-yield bonds, creating a performance divergence.

Unlike the public equity markets, software exposure in credit markets is concentrated in private, not public, companies. An estimated 80% of these issuers are private, and 50% are rated B- or lower, creating a unique and more challenging risk profile due to lower credit quality and less transparency.

A consistent 2-5% of Europe's public high-yield market restructures annually. The conspicuous absence of a parallel event in private markets, which often finance similar companies, suggests that opacity and mark-to-model valuations may be concealing significant, unacknowledged credit risk in private portfolios.

The traditional two-tier credit market (investment grade and high-yield) has evolved. A new four-tier hierarchy of credit quality now exists: Investment Grade, High Yield, Leveraged Loans, and finally, Private Credit, which has absorbed the riskiest deals that cannot find financing in the other markets.

If redemption requests outpace inflows, private credit funds are forced to sell assets. They will naturally sell their most liquid, highest-quality loans first. This creates a death spiral, leaving the remaining portfolio more leveraged and concentrated with lower-quality, harder-to-sell assets.

The public high-yield market's improved quality is partly because the riskiest companies migrated to private markets. These lower-quality borrowers moved to private credit for easier access to capital, concentrating default risk in that less-regulated space.

When facing a downturn or redemption pressures, private credit funds cannot easily sell their troubled, illiquid loans. Instead, they are forced to sell their high-quality, liquid assets, creating contagion risk in otherwise healthy public markets.

The massive growth of private credit to $1.75 trillion has created an alternative financing source that helps companies avoid default. This liquidity allows them to restructure and later refinance in public markets at lower rates, effectively pushing out the traditional default cycle.