The Federal Reserve begins raising interest rates, making private credit even worse

The Federal Reserve's new round of interest rate hikes is pushing the already beleaguered private equity industry into even more dangerous territory. A record $349 billion is trapped in "zombie funds", exit channels remain clogged, and fundraising volume has plunged to multi-year lows—the intensity of this crisis is escalating along with the upward trend in the yield curve.

The Fed announced a rate hike this Wednesday, directly hitting the private equity industry’s hopes for a market recovery since the beginning of the year. Previously, the industry had generally hoped that new Fed Chair Walsh, appointed by Trump, would push for rate cuts, and deal activity had briefly picked up. However, with rates rising instead of falling, about $500 billion in private funds entering their 7th to 10th years face the risk of being unable to exit on time, and the scale of "zombie funds" is expected to expand further.

According to the Wall Street Journal on September 17, the impact of rate hikes is multifaceted: portfolio companies face higher loan costs, asset sales become more difficult, software investments are hit by the AI wave, and private credit businesses are also experiencing turbulence. Leading alternative asset managers such as Apollo, Blackstone, and KKR have seen their share prices drop noticeably this month as rate hike expectations intensified. Apollo Co-President Scott Kleinman admitted that some managers who grew rapidly over the past decade will have to scale back.

Zombie Funds Reach Record Scale, Exit Blockage Creates Vicious Cycle

The private equity industry's "zombie nightmare" is far from over. According to PitchBook data, assets trapped in zombie funds—those exceeding 10 years in life with no exit—have surged by about 65% from the end of 2021 to the end of 2025, with a record $349 billion in capital investors are eager to recoup.

The private equity business model relies on completing a full "buy-value-add-exit" cycle within about 10 years: fund managers, backed by their own capital, raise funds from institutional investors such as pensions and insurance companies, add leveraged loans shouldered by the acquisition targets, ultimately sell for cash, repay the loans, collect management fees and return profits to investors.

Rising interest rates directly undermine this entire logic chain. Portfolio companies’ floating-rate loan costs rise in lockstep with benchmark rates, potential buyers are unwilling to pay the valuation prices private funds need when financing costs are high, and transactions struggle to close. After the Fed’s rate hikes in 2022, asset sales by portfolios held by private equity slowed dramatically; this latest rate hike will push even more funds into the "zombie" category.

Kroll Managing Director Mitchell Mansfield stated:

“You will see more funds enter zombie status. The longer these funds last, the more investors' capital returns stagnate, and then decline.”

Fundraising Winter Intensifies, Manager Shakeout Looms

Exit blockages feed directly into the fundraising side. Private equity fundraising this year is heading towards at least the worst levels since 2020. According to PitchBook, as of September 11, the industry has raised $211.9 billion this year; the total for all of 2025 is expected to be $334.4 billion, down from $376.9 billion the previous year, showing a clear downward trend.

Institutional investors are tightening their commitments. Angela Rodell, former CEO of the Alaska Permanent Fund and now Senior Advisor at Star Mountain Capital, stated that going forward, investors "will only renew specific relationships in which they have confidence, and more private funds will therefore close."

The average return for private equity funds in 2025 is about 7%, the weakest since 2011, despite the broader US economy maintaining strong growth. Declining returns make it harder for pensions, insurance companies, and endowments to meet their financial targets, while capital locked in funds and unable to be reinvested exacerbates the predicament.

Apollo Co-President Scott Kleinman said candidly at Monday’s analyst meeting: "I do think the number of managers will decrease and that managers who have expanded rapidly over the last decade will have to shrink." He also said Apollo is still able to attract investors because its recent fund returns outperform the industry average.

Software Investments Take Heavy Hits, AI Impact Compounds Rate Pressure

In addition to rate hikes, private equity faces another layer of pressure: having made massive bets on the software industry over the past decade in a low-rate environment, they now face the shock of AI disruption. According to PitchBook, on average, private equity has allocated about 14% of its funds to software companies, with much of this activity concentrated in the low-rate trough of 2020–2021.

As loans supporting these acquisitions come due, defaults are expected to surge in both the next year and in 2028. Reports indicate that Thoma Bravo has already lost $5 billion on its investment in customer service software firm Medallia this year—after its default, the company was taken over by lenders. Thoma Bravo is currently in talks with debt investors to extend loans on other software companies in their portfolio, including cybersecurity company Sophos.

Clearlake Capital finds itself under similar pressure. This Santa Monica, California-based firm, known for its tech investment expertise, expanded its assets under management from about $8 billion in 2017 to $185 billion, but some software investments have faced headwinds.

According to regulatory filings by private credit funds, lenders have marked down by more than 30% the $2.1 billion loan to HR software company Cornerstone OnDemand and the roughly $1.5 billion loan to medical software provider Symplr Software. Clearlake is negotiating solutions with holders for both loans.

Benefit Street Partners Portfolio Manager Anant Kumar noted: “In the long run, if high rates persist, these companies will face greater cash flow pressure, and defaults will occur with greater frequency.”

Private Credit Under Pressure, Industry Ecosystem Faces Restructuring

Another core business for private equity managers—private credit—is also affected by the rate hike shock. Persistently high rates will cause turmoil in the private credit market, further eroding managers' overall sources of income.

Currently, private equity funds manage over $2 trillion in assets in the US, and their stress is transmitting into the wider financial system, affecting pensions and insurance companies that rely on private equity exits for returns.

Sara Werner, partner at Lowenstein Sandler LLP, stated: “It’s ridiculous to say private equity’s golden era will never return because the market is cyclical, but the question is just how long can these funds wait to reach the valuations they want.”

Analysis suggests the logic chain of expanding zombie funds → greater fundraising difficulty → declining management fee revenue → accelerated industry consolidation is becoming increasingly clear as interest rates move higher again.