A growing class of investors is targeting opportunities in the private credit secondary market as recent disruptions increase demand for liquidity. Private credit secondary funds, similar to those in private equity, acquire positions that existing investors or fund managers wish to sell, including stakes in funds or underlying loans.

This trend has emerged in response to heightened redemption pressures. Older private credit funds, typically aimed at institutional investors, face demands to return capital, while semi-liquid funds marketed to retail investors have experienced unusually high exit requests. Some investors have sought redemptions exceeding the usual quarterly limit of 5% of net asset value (NAV), driven in part by concerns over loans tied to sectors vulnerable to artificial intelligence-related disruption, such as certain software companies. Despite these pressures, outflows from the ten largest private credit funds were largely confined to the standard redemption limits, with a net withdrawal of $1.8 billion in the first quarter, according to data from Morningstar.

Fund managers of semi-liquid vehicles are challenged with balancing these redemption demands against the need to maintain sufficient liquidity. A consistent redemption rate of 5% per quarter equates to a fifth of the fund annually, which may strain yield generation, loan turnover, and available cash. This scenario has created openings for secondary investors to provide liquidity solutions. These investors can adopt a more aggressive stance by purchasing assets at discounted prices from sellers compelled to exit or position themselves as partners offering orderly liquidity.

One approach involves selling a portion of loans to special purpose vehicles backed by secondary funds, allowing semi-liquid funds to access additional cash while continuing to earn management fees on the underlying loans. Depending on the urgency of a fund’s liquidity needs, buyers may negotiate more favorable terms, such as deferring payment even if loans are valued at NAV.

While the private credit secondary fund market has grown quickly, it remains limited in scale compared to the broader private credit industry, which manages assets exceeding $2 trillion. For instance, Ares Management recently raised about $7 billion from institutional investors for secondary credit opportunities. This relative scarcity of dedicated secondary funds indicates room for expansion in the segment.

Some industry observers suggest that semi-liquid funds not currently under stress could still benefit from having secondary sales as an option to boost liquidity. Additionally, there is an argument that redemption requests from investors may be overstated amid a rush to exit positions, implying that allowing redemptions beyond the 5% threshold might alleviate overall redemption pressure.

However, this strategy raises concerns that carving loans out of semi-liquid funds merely relocates underlying credit risks rather than resolving them. Credit quality remains a key consideration, as transferring assets does not eliminate potential problems within the loan portfolios.

Overall, private credit secondaries are becoming an increasingly important component in managing liquidity for funds exposed to retail investor flows, representing a novel tool in a sector that has expanded beyond its traditional institutional roots.