Private credit has rarely felt so “public.” In early 2026, worries about AI’s potential to disrupt software business models collided with a surge in redemption requests from evergreen direct lending strategies. Suddenly, questions about elements of private credit that usually stay in the fine print—liquidity terms, valuation marks and portfolio quality—moved into the headlines.
To check into what could come next, investors may want to look past the broad “private credit” label and focus on its largest segment by assets: direct lending.1 Morgan Stanley Wealth Management’s Global Investment Office believes that direct lending is entering a new phase, in which:
- returns normalize
- redemption requests may remain elevated
- careful manager selection is even more critical
What is direct lending?
Direct lending occurs when a non-bank lender, such as a direct lending fund or investment manager, provides credit directly to a company—often a middle-market business—without a traditional bank in the middle. Loans are privately negotiated and typically held by the lender rather than traded.
Investors usually access direct lending through professionally managed funds. Examples include semi-liquid “evergreen” funds and publicly listed business development companies (BDCs). Returns are driven mainly by income—in the form of interest payments and sometimes fees on the loans—paid to investors through periodic distributions or dividends.
What is the outlook for direct lending?
Morgan Stanley’s Global Investment Office believes direct lending returns may normalize amid lower base rates, tighter spreads and higher credit losses.
In recent years, direct lending benefited from higher base rates and a relatively attractive yield cushion, or “spread,” over base rates—with total returns sometimes pushing into the double digits. Nevertheless, those tailwinds have faded since the Federal Reserve began cutting its policy rate in 2024. Today, while stated yields may still look attractive, total returns could soften due to:
- Lower base rates: Direct lending portfolios are typically tied to floating benchmarks, so the Fed’s easing since September 2024 has reduced income on new and resetting loans.
- Tighter spreads: Loans reflect broader spread tightening in high yield bonds and leveraged loans from late 2023 through 2025. For recently originated loans, spreads have begun widening.
- Higher credit losses: Direct lenders may see increasing realized losses as a result of higher default rates in the underlying loans.
These drivers will likely combine to normalize direct lending’s returns, suggesting that manager execution and loan selection become more important.
How easily can investors exit evergreen direct lending funds?
“Evergreen funds”—a widely used investment vehicle in direct lending—are semi-liquid: Redemptions are typically quarterly and often capped to about 5% of the fund’s net asset value, so exits can take time. If too many investors request a redemption at once, fund managers may pro-rate redemption requests. That can leave some investors waiting through multiple redemption windows to reduce their position.
For fund managers, persistent outflows can be a challenge, too: To meet the requests, the managers may have to sell assets, potentially at unfavorable times, or increase borrowing, which can raise financial risk. Either way, persistent outflows can constrain their flexibility and weigh on investor sentiment, even if credit fundamentals are not broadly breaking down.
Why does manager selection matter in direct lending?
As recent tailwinds fade in direct lending, performance will likely depend more on underwriting discipline, portfolio monitoring and risk controls. For investors, this makes careful selection of fund managers more important than ever.
Some investors are increasingly scrutinizing signals in direct lending that may indicate lower-quality assets, such as:
- payment-in-kind income (interest the borrower doesn’t pay in cash and instead adds to the loan balance)
- non-accruals (loans the manager flags as troubled and stops treating as accruing interest income)
- realized losses (losses the fund has actually recognized on loans, such as after a restructuring, payoff or sale).
How can investors find opportunities in direct lending?
One place sentiment can show up quickly is in publicly listed direct lending funds known as business development companies, or BDCs, whose shares trade daily and can swing to premiums or discounts relative to their reported net asset value (NAV), even if that underlying portfolio value changes more gradually.
Importantly, distributions serve as the main contributor to total returns for listed direct lending BDCs. When such funds trade at a discount to NAV, the quoted distribution yield can look higher because it is calculated off a lower share price. For selective investors, steep discounts can create tactical entry points when yields look unusually compelling.
Where are there private credit opportunities today?
Direct lending has navigated the ups and downs of past credit cycles and has historically delivered income through regular distributions. Still, the near-term setup looks less favorable for direct lending than it did a few years ago, as the strategy digests troubles in concentrated segments of the market, lower base rates, tighter spreads and heavier lender competition.
For investors with fresh capital, opportunities may increasingly open in other corners of private credit, including asset-based finance and distressed or opportunistic credit, where loans are backed by specific assets—or bought at discounted prices during periods of stress, offering a different set of risks and potential returns than traditional direct lending.
Morgan Stanley Wealth Management’s industry-leading alternative investments platform, supported by the rigorous analysis and insights of our Global Investment Manager Analysis (GIMA) team, provides access to more than 200 alternative funds across the liquidity and eligibility spectrum.
To learn more, ask your Morgan Stanley Financial Advisor for a copy of the Global Investment Office report, “Alternative Investment Insights: Private Credit: Digging into Direct Lending.”
