This is the third article in our Wall Street Fugazi series teaching you how to use Wall Street without Wall Street using you. [Read the full framework for protecting yourself from Wall Street’s sales culture.]
The retail private credit boom started five years ago when Blackstone launched a perpetual private credit fund targeted to individual investors that raised almost $16 billion in its first year. Suddenly, private credit was the shiny new product on Wall Street, replacing private equity where returns were falling in the face of excess capital and rising interest rates.
After years of low interest rates, high-net-worth individuals piled into private credit funds marketing 8-12% yields. The sales pitch sounded simple enough: a secure, exclusive investment offering high yields by being the premium, low-friction lender to mid-sized corporate borrowers abandoned by traditional banks.
What actually happened?
1. Returns fell as capital raising soared
The massive inflow of retail capital into private credit replicated the “too much money chasing too few good deals” problem dragging down private equity. Private credit managers needed to deploy massive sums of money quickly to earn their management fees.
Predictably, underwriting standards degraded and unexpected problems surfaced:
- Covenant-lite debt means less protection for investors: Traditional protective financial covenants (such as leverage limits and minimum interest coverage ratios) were eroded or even stripped away to win deal flow.
- Aggressive EBITDA adjustments mean less cushion for investors: Lenders accepted heavily engineered corporate earnings figures riddled with speculative add-backs and cost-synergy assumptions – effectively masking true borrower leverage.
- Lender conflicts create new risks for investors: As companies falter, lenders can turn on lenders in a zero-sum game. Majority lender syndicates team up to squeeze minority lenders, creating a previously unrecognized risk in this “safe” asset class.
Inadequate underwriting eventually taught investors an important lesson: your promised yield and your investment return can be very different.
2. The illusion of yield when investors stop being paid cash
When borrowers stumble, many private credit managers turn to allowing payment-in-kind (PIK) in place of cash interest payments. With PIK, struggling corporate borrowers who cannot afford to pay cash are allowed to issue more debt to the fund instead.
PIK arrangements inflate retail investors’ tax and fee burdens:
- Phantom income creates tax drag: The private credit fund reports an 11% yield, but when a substantial portion of that yield is accrued on paper, not cash, the fund passes through more “income” than it actually pays out to investors. This leaves investors paying real cash taxes on non-cash paper promises.
- Artificial loss deferral keeps fees elevated: By extending PIK terms, fund managers grow the fund instead of shrinking it by recognizing debt write-downs. This delay keeps net asset value (NAV) high and funds collecting increased management fees.
For example, private credit financed roughly $2 billion of Thoma Bravo’s 2021 leveraged buyout of software firm Medallia. The loan terms allowed Medallia to use PIK to cover over 60% of the loan’s interest payments. This means that while the total interest bill was roughly $1.3 billion by the end of 2025, only about $500 million was paid in cash. The rest was private credit receiving roughly $800 million of additional paper promises which the IRS counts as interest paid. That implies over $400 million in cash taxes paid on paper interest at the combined tax rate for a high-income California-based investor.
This phantom interest is unlikely to ever be actually paid given lenders marked down their positions roughly 40% after the company defaulted in early 2026. To add insult to injury, private credit investors also paid millions of dollars of additional management fees on that $800m of additional debt created by PIK.
3. Fund gates lock up investors’ money
Perhaps the most acute risk exposed by private credit’s retail push is the structural mismatch between investors’ liquidity expectations and private credit’s illiquid underlying assets. Retail private credit funds routinely offer quarterly tender offers, generally capped at 5% of fund NAV, that give investors a false sense of liquidity.
During good times, the 5% cap is irrelevant because more money is flowing into the fund than wants to leave. Of course, some investors exit, and they get 100% of their money immediately. This creates an illusion of full liquidity, until circumstances change.
When economic pressure mounts and many investors seek to withdraw money, managers implement their 5% caps (called “gating the Fund”). Fund gates slamming shut across retail private credit funds in 2025–2026 taught investors a painful lesson Wall Street failed to emphasize in the pitch decks: redemption rights that the fund manager can suspend aren’t real liquidity. A 10-year illiquid loan cannot be transformed into a liquid investment by wrapping it in a private credit fund structure.
For example, in the first quarter of 2026, the Blue Owl Tech Income Fund reportedly received redemption requests for more than 40% of the Fund’s capital. Because of the 5% cap, investors only received one-eighth of the money they sought to withdraw.
The end result of retail capital flooding into opaque private credit debt pools? Wall Street collects lucrative management fees on bloated loan volumes while individual investors are left holding tax-inefficient, paper-yielding debt prone to sudden liquidity lockups.
Private credit isn’t a fugazi; private credit sold as a safe, high-yield, liquid opportunity is very much a fugazi. Particularly when promised yield is conflated with expected return, and a redemption feature is marketed as providing real liquidity.
Continue the Wall Street Fugazi series with Are Structured Notes Good Investments?
Understand What You’re Really Investing In
A fee-only fiduciary can help you look beyond the promised yield to evaluate the taxes, fees, liquidity, and risks that can ultimately determine your investment outcome.
Disclaimer:
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