As skeptics scrutinize potential cracks in private credit markets, institutional investors say niche segments are proving resilient and lucrative, even as rising retail inflows and concentration concerns in software and artificial intelligence push allocators toward more specialized, less commoditized areas of the sector.
The $129.3B Virginia Retirement System is among a growing number of institutional investors increasing exposure to private credit amid volatility tied to tariffs, inflation concerns and geopolitical uncertainty.
Steve Woodall, program director for credit strategies at the VRS, said the pension fund is spending most of its time evaluating less commoditized areas of the market where managers have a clear competitive edge.
“For example, we increased our focus on asset-backed and specialty finance opportunities during a pullback in lending by regional banks in 2023-2024,” Woodall said in an email to Markets Group. “Within that framework, we seek opportunities that are scalable and can play a meaningful role in the portfolio for years to come.”
Private debt has become a major financing source for private equity-backed companies, with borrowers increasingly drawn to the asset class for its speed and execution efficiency. According to S&P Global, the private equity market contained roughly $2.5tn of dry powder as of mid-2025.
A 2026 PitchBook report found that 206 private debt funds reached final closes in 2025, raising a combined $221.2bn. While that marked a 7.8% year-over-year decline, PitchBook said late-reporting funds could still push annual fundraising into positive territory.
To Woodall, income generation remains one of the most attractive aspects of private credit, particularly during periods of slower distributions from private equity and other alternative asset classes.
“We also find some markets within private credit have attractive correlation benefits against the broader economy,” said Woodall. “These are in addition to the general benefits of private credit, which include spread premium over public fixed income, lower mark-to-market volatility and broader diversification benefits that continue to play a role in the attractiveness of the asset class.”
At the VRS, private credit investments sit within the pension fund’s broader Credit Strategies portfolio, which also includes distressed, mezzanine and structured credit strategies.
“Beginning in our [fiscal year] 2005, we shifted our higher-risk exposures — at that time predominantly high-yield bonds — into the newly created Credit Strategies program,” said Woodall. “Over time the program has shifted its focus to private credit, which makes up over 95% of Credit Strategies today.”
As of April 23, 2026, the credit portfolio had a net market value of $19B and represented 14% of the total portfolio versus a 16% benchmark. As of June 30, 2025, the VRS Credit Strategies program generated a 9.1% return, outperforming its custom benchmark of 8.3%. The portfolio is primarily allocated to direct lending (26%), opportunistic credit (20%), diversified private credit (19%), mezzanine (12%), asset-backed lending (11%), distressed debt (9%), high-yield loans (3%) and bank loans (1%).
Woodall noted that higher yields in parts of the private credit market have been supported by bank retrenchment and structural shifts that began following the Global Financial Crisis.
Indeed, a report cited by Oliver Wyman found banks’ share of lending to U.S. households and nonfinancial businesses has fallen from roughly 60% in the 1970s to about 35% today. The shift mirrors a broader industry trend toward asset-backed lending and specialty finance as traditional direct-lending markets become increasingly crowded.
Woodall said the VRS does not expect that trend to reverse over the long term.
“While big banks will continue to grow market share and compete with large, upper market private credit managers, the steady decrease in regional and local banks opens opportunities for lending in the private markets,” he said.
Still, increased flows into private credit have begun creating new pressures throughout the market.
PitchBook reported that capital formation in private debt is no longer being driven solely by institutional fundraising, with insurance companies and private wealth increasingly entering the asset class. Of the more than $2.0tn in private debt AUM, retail investors accounted for 15.1%, while insurance capital represented an estimated 7.2%.
The effects of those inflows have begun reverberating throughout the market, as recent defaults and liquidity strains have prompted some investors to request redemptions, forcing certain managers to contend with redemption queues and gates.
To Cameron Mock, executive director and chief investment officer of the $1.1bn Laborers’ Annuity and Benefit Fund of Chicago, recent headlines surrounding redemption pressures have become somewhat self-reinforcing.
While he acknowledged redemption queues can be unsettling, particularly for investors with liquidity constraints, he believes much of the reaction has been amplified by headlines rather than underlying credit deterioration.
“People see the headline and then a lot of the retail investors kind of flock to redemptions,” he said, noting that once the “redemption queue hits,” others often follow in a race to submit withdrawal requests.
But redemption gates are functioning largely as intended, he added. Mock also pointed to stronger underwriting standards and lower loan-to-value ratios than those seen during the Global Financial Crisis, arguing that today’s private credit market is structurally more resilient.
According to the LABF’s latest published asset allocation targets, the pension fund allocates 19% to core fixed income, 5% to liquid opportunistic credit, 2% to emerging market debt and 3% to private debt, representing a combined credit and fixed income target allocation of roughly 29% of the overall portfolio.
Manager selection remains critical in private credit, said Mock, particularly as retail participation in alternatives continues to grow.
At the same time, he expressed concern about the continued expansion of private markets products into the retail channel, arguing that there remains “a huge asymmetric information problem between those selling the private credit vehicles and the retail investor itself.”
He also warned that private equity managers with heavy exposure to software deals could face “some serious pain” amid ongoing AI-driven disruption, while senior positioning in the capital structure and disciplined leverage remain key protections within private credit.
Woodall said the VRS has not been materially affected by recent market stresses, though the pension fund continues to monitor both portfolio risks and broader market conditions closely.
“Liquidity provisions have the potential to create problems for both managers and investors,” he said. “In order to mitigate those types of risks, the VRS has generally accessed its private credit investments via closed-end funds or in fund-of-one structures where the VRS retains a larger degree of control.”
He echoed Mock’s concerns around growing concentration risk tied to software and AI-related exposure across parts of private markets, noting that some areas of capital markets have become increasingly interconnected in recent years. According to a 2026 Coutts report, direct lending has emerged as a growing concern within private credit markets following several high-profile defaults and sizable exposure to software companies, while Partners Group estimates software accounts for roughly 20% of the U.S. direct-lending market and as much as 30%-35% when adjacent industries are included.
That interconnectedness reinforces the VRS’ diversification approach across sectors, borrower types, structures and managers, Woodall said, rather than viewing private credit strategies in isolation.
“In practice, that means a more balanced portfolio across sub-strategy types and emphasizing structural protections and collateral quality so that diversification enhances downside protection rather than diluting return potential,” he said. “We are highly focused on building a well-constructed portfolio and remaining disciplined on credit quality and manager selection.”