The Liquidity Illusion

What Happens to Private Credit When Markets Break

A Client Perspective | January 2026

There is a structural problem hiding inside many investor portfolios right now, and it
tends to stay hidden right up until the moment it matters most.

Over the past several years, the financial industry has packaged private credit and other
illiquid alternative assets into publicly traded or semi-liquid wrappers. Interval funds.
Non-traded REITs. Business development companies. Tender offer funds. The pitch has
been straightforward and appealing: access the return premium of private markets
without giving up the liquidity of public ones.

It is a seductive proposition. It is also, in our view, built on a fundamental contradiction, one that becomes visible only when markets experience stress. That is precisely when
investors discover that the liquidity they thought they had does not actually exist in the
form they expected.

This piece explains the mechanics of that problem, what it looks like in practice, and
what sophisticated investors should be asking before allocating to these structures.

The Core Problem: You Cannot Make Illiquid Assets Liquid by Changing
the Wrapper

Private credit – direct lending, mezzanine debt, specialty finance – has characteristics
that are structural, not incidental. Loans are negotiated bilaterally. They do not trade on
an exchange. Valuations are conducted infrequently, often quarterly, using models
rather than market prices. When a borrower encounters difficulty, resolution happens
through negotiation and restructuring, not through a bid-ask spread.

These characteristics are not flaws. They are part of why private credit has historically
delivered a return premium over public bonds. Investors are compensated for illiquidity.
The tradeoff is explicit and, for the right investor with the right time horizon, entirely
reasonable.

The problem arises when that illiquid asset is placed inside a structure that promises
or implies that investors can exit on relatively short notice. The asset has not changed.
The underlying loans are still bilateral, infrequently valued, and difficult to sell quickly.
But the wrapper now carries an expectation of liquidity that the underlying portfolio
cannot reliably support.

 

The asset has not changed. What changed is the promise attached to it,
and that promise is the one that breaks first.

 

What Happens When Volatility Arrives

In calm markets, the mismatch is invisible. Redemption requests are modest and
manageable. The fund accumulates enough cash from loan repayments and new
subscriptions to meet outflows without forced selling. Everything appears to function as
advertised.

When markets turn volatile, the dynamic reverses quickly. Redemption requests spike.
New subscriptions slow or stop. The fund now faces a gap between what investors want
to take out and what the portfolio can actually deliver without selling assets at distressed
prices, or at all.

The fund has a few options at this point, and none of them are good for investors who
want liquidity. It can gate redemptions, meaning it limits or suspends withdrawals. It
can queue requests, processing them slowly as cash becomes available. Or it can sell
assets into a thin, distressed secondary market at significant discounts, destroying value
for the investors who remain.

The investors who fare worst are often not the ones who panicked. They are the ones
who submitted redemption requests in good faith — expecting the liquidity the structure
implied — and found themselves waiting months for partial redemptions at uncertain
valuations.

The Blackstone BREIT Episode: A Case Study in Plain Sight

The most prominent recent illustration of this dynamic played out publicly with
Blackstone’s non-traded REIT, BREIT, beginning in late 2022. BREIT held primarily
real estate assets, institutionally managed, high quality by most measures, inside a
structure marketed to high net worth investors with monthly liquidity provisions.
When interest rates rose sharply and real estate sentiment shifted, redemption requests
surged. In November 2022, BREIT received redemption requests exceeding its monthly
limit. The fund implemented its gate provisions, provisions entirely within its contractual rights,  and began limiting withdrawals. The gates remained in place through much of 2023.

It is worth being precise about what happened: the fund did not fail, and Blackstone did
not act improperly. The gate provisions were disclosed. But many investors experienced
a jarring gap between the liquidity they assumed they had and the liquidity they actually
had when they needed it. That gap, the one between implied and actual liquidity, is exactly
what we are describing.

Similar dynamics, if less visible, played out across interval funds holding private credit
during the COVID volatility of early 2020. Funds that had marketed themselves on the
basis of quarterly liquidity found themselves managing redemption queues and
reducing distributions as their underlying portfolios were stress-tested.

The Valuation Problem Compounds Everything

There is a second issue that runs alongside the redemption problem, and it is subtler but
equally important: valuation opacity.

Private credit assets are not marked to market daily. They are valued periodically, using
methodologies that involve significant judgment. During periods of market stress,
publicly traded credit instruments, for example corporate bonds, and leveraged loans  often sell off
sharply, reflecting real-time market sentiment. Private credit portfolios, by contrast,
may continue to carry positions at or near par for quarters after market conditions have
deteriorated.

This creates a perverse dynamic in a liquid wrapper. Investors who redeem early, before
valuations are marked down, effectively exit at prices that overstate the portfolio&’s
current value. The remaining investors absorb the subsequent markdown. This is
sometimes called return laundering, or the stale NAV advantages early redeemers at the
expense of those who stay.

In a pure institutional private credit fund with long lock-ups and sophisticated
investors, this is a manageable nuance. In a structure with frequent liquidity provisions
and retail or near-retail investors, it creates real fairness and structural concerns.

What Investors Should Be Asking

None of this means that private credit is a poor investment. It can be an excellent one in
the right structure, with the right manager, and most importantly with a time horizon and
liquidity profile that matches the underlying assets. The question is not whether to
invest in private credit. The question is whether the structure you are investing through
is honest about what liquidity you actually have.

Before allocating to any semi-liquid or publicly traded vehicle that holds private credit,
investors should ask clearly: What are the gate provisions, and under what conditions
have they been triggered historically? How frequently are assets valued, and what
methodology is used? If I request a redemption during a period of market stress, what is
a realistic timeline for receiving my capital? What percentage of the portfolio is actually
liquid at any given time?

If the answers to those questions are vague, incomplete, or buried in fine print, that is
itself informative.

The right question is not whether private credit is a good investment. The
right question is whether the structure you are using is honest about the
liquidity you actually have.

Our Approach

When we construct portfolios that include private credit for our clients, we do so
through structures where the liquidity terms match the asset. That typically means
genuine lock-up periods, limited partnership structures, or separately managed
accounts, not wrappers that offer the appearance of liquidity without the reality.
We are also deliberate about sizing. For clients who may need to access capital within a
defined time horizon, we hold that capital in genuinely liquid instruments. Private credit
allocations are funded from capital the client does not expect to need. This is not sophisticated portfolio theory. It is the basic discipline that the bundled product wrappers often obscure.

The appeal of private credit in a liquid wrapper is understandable. The returns of private
markets with the access of public ones sounds like a free lunch. Our experience, and a
growing body of recent evidence, suggests that free lunches in financial markets tend
to come with hidden terms. In this case, the hidden term is that liquidity provision is
conditional, not guaranteed, and the conditions under which it disappears are precisely
the conditions under which you are most likely to want it.