Private credit’s hot streak is over

Private-credit firms delivered eye-popping returns to investors in recent years. That hot streak is over.

The latest earnings results across the industry show returns that appear to be entering a more modest chapter, just as investors have grown worried about other aspects of private-credit funds that lend to riskier companies.

Ares Capital Corp., Golub Capital and other publicly traded funds marked down their net asset values in the last quarter after lowering the valuations of loans they made to software and other companies. Others like Sixth Street Specialty Lending also trimmed their dividends.

Apollo Global Management said this past week that gross returns on its direct origination funds that include investment-grade loans to companies were 0.5%, down from 2.6% a year ago. Gross returns reflect dividends paid to investors as well as their investment’s change in value, before fees.

Earlier, Blackstone and Blue Owl also reported lower returns for the period from a year ago.

Just a few years ago, investors had enjoyed mid- to high-double-digit annual gross returns, fueled by a confluence of unusual circumstances. During the pandemic, for instance, private lenders stepped up to supply credit to borrowers when others were pulling back, earning strong returns for doing so. That was followed by a dealmaking frenzy that drove up demand for borrowing.

Then, when the regional-banking crisis hit in 2023 and banks pulled back on this lending, private-credit firms took more share.

Now the industry is being hit by challenges. After ramping up lending to software companies over the past decade—partly for their recurring revenue—many funds are now contending with the possibility that artificial intelligence could render those companies obsolete.

Wealthy individual investors have rushed to get their money back over worries about the broader health of the funds. Many funds that are open to individuals limit how much money can be redeemed each quarter to prevent runs on the funds. That has intensified investor anxiety.

The worries come as the industry has been pushing to more aggressively court individual investors and tap in to the vast pool of money in 401(k) and similar retirement plans.

Executives said in calls with analysts that the fears have been overblown and fueled by media coverage of a small number of defaults. Some stressed that they had prudent underwriting controls while warning of bad players in the sector.

Apollo Chief Executive Marc Rowan said Wednesday that greater transparency on fund values is needed for trust and reputation, and that his firm plans to offer investors daily pricing across its private-credit funds by the end of September.

“New buyers particularly want more transparency around private assets,” Rowan said.

In a recent interview, Blackstone President Jonathan Gray attributed the declines in gross returns primarily to the Federal Reserve’s interest-rate cuts. He said an uptick in defaults is also contributing.

“Two years ago we had abnormally low levels of defaults, and now we’re getting more normalization in that,” Gray said.

Private-credit firms note that their returns are still outperforming public-loan markets. In the first quarter, for instance, a public leveraged loan index was down 0.6%.

Total returns for the Cliffwater Direct Lending Index, a measure of how loans made to middle-market companies perform, outpaced public loan markets for 15 of the last 21 years, including last year, according to a Goldman Sachs report.

“The question is will private credit continue to outperform public credit or not?” said Glenn Schorr, an analyst at Evercore ISI.

Private-credit executives say the recent worries roiling the industry have mostly been concentrated among individual investors, rather than institutional clients such as pensions and endowments that over the years have increased their exposure to private markets.

Blackstone and Apollo continued to attract investor money, reporting 18% and 30% year-over-year increases, respectively, in the first quarter for their credit divisions’ assets under management.

Blue Owl also reported higher overall assets under management from a year ago, an increase that was driven by institutional clients. In its private-wealth channel, fundraising declined.

Write to AnnaMaria Andriotis at annamaria.andriotis@wsj.com