private equity

BOJ Review: Recent Trends in Private Funds

Norbert Gehrke

15 Sep 2025 — 5 min read

This week, the Bank of Japan (BOJ) has published a new paper out of the "Bank of Japan Review" series, examining the recent trends in Private Equity (PE) and Private Debt (PD) funds, which have significantly expanded their assets under management (AUM) since the Global Financial Crisis (GFC), particularly in the United States.

The paper finds a divergence in performance:

PE funds are facing headwinds, with performance weakening due to lower portfolio company valuations and higher financing costs amid global interest rate hikes. This has led to a significant slowdown in "exits" (selling portfolio companies).
PD funds have shown robust performance, benefiting from wide lending spreads and floating-rate loans. However, intense competition is beginning to tighten these spreads.

A key concern is the financial health of the underlying portfolio companies. While their business performance remains solid, they face a growing interest burden. The paper also highlights increasing interconnectedness between these private funds and the traditional financial system, including Japanese banks and institutional investors. This growing linkage elevates the potential impact of stress in the private markets on Japan's financial system, necessitating close monitoring.

1. Introduction and Market Growth

Private funds, which raise capital from investors in private placements, have become a major force in global finance. PE funds (which take equity stakes in private companies) and PD funds (which provide loans, often to the same companies) have seen remarkable growth. This expansion is driven by investors seeking higher yields and diversification in an era of low interest rates. The AUM for PE and PD funds has expanded consistently and is projected to continue growing.

PE funds grew by offering high returns in the post-GFC low-rate environment.
PD funds emerged as a key source of financing for small and medium-sized enterprises, filling a gap left by banks facing stricter regulations. Their high yields, backed by significant lending spreads, also attracted strong investor demand.

The paper notes that Japanese institutional investors (life insurers, pension funds) and major banks have deepened their ties with these funds, making their performance and stability crucial for Japan's financial system.

2. Performance Trends

A. Private Equity (PE) Fund Performance

After a decade of strong performance, PE funds have struggled since 2022. The Internal Rate of Return (IRR) has declined across all major strategies (Buyout, Growth, Venture).
The decline is most pronounced for "Growth" and "Venture" strategies, which are more sensitive to interest rate hikes.
By "vintage" (the year a fund was established), funds from 2020-2021 are performing particularly poorly. These funds invested at peak market valuations, often with high leverage, making them vulnerable to the subsequent downturn.

B. Private Debt (PD) Fund Performance

In contrast, PD funds have maintained strong performance, largely because their loans are typically floating-rate, allowing them to benefit from rising interest rates.
However, competition is heating up. While spreads remain high, they have started to tighten due to competition among PD funds and from banks re-entering the leveraged loan market. For large deals like Leveraged Buyouts (LBOs), some borrowers are now opting for bank-provided leveraged loans, which may offer lower spreads than PD funds.

3. Capital Flow Dynamics: The Exit and Fundraising Logjam

The flow of capital is a critical aspect of the private fund ecosystem.

PE Fund Exits: Exits—the sale of portfolio companies via M&A, IPOs, or secondary sales—are the primary way PE funds return capital to their investors (LPs). Since 2022, exit activity has stalled. High interest rates and market uncertainty have created a valuation gap between buyers and sellers, making deals difficult to close. This "exit logjam" directly impacts LPs' cash distributions.
Fundraising: The slowdown in exits has a direct knock-on effect on fundraising. With distributions from older funds slowing, LPs have less capital to commit to new funds. As a result, fundraising for PE funds has stagnated. PD fundraising has also slowed, as many of their lending opportunities are tied to PE-led buyouts, which have become less frequent.

4. Credit Quality and Emerging Risks

A. Portfolio Company Health

Despite a resilient US economy, portfolio companies face significant financial pressure. Higher interest rates are eroding their ability to service debt. A declining Interest Coverage Ratio (ICR) for leveraged loan borrowers (a close proxy for PE portfolio companies) indicates a weakening of the portfolio companies' debt repayment capacity.

B. Default Rates and Potential Forbearance

Official default rates for PD fund borrowers have not risen dramatically so far. The paper suggests this may be because PD funds, having close relationships with their borrowers, can intervene early to facilitate workouts.
However, there is a risk that low defaults are masking underlying stress through forbearance. The paper points to an increase in PIK (Payment-in-Kind) loans, where interest is deferred until maturity. While a legitimate tool, its increased use could be a way to postpone recognizing credit problems. The prevalence of "covenant-lite" loans also reduces early warning signals.

C. Increased Fund-Level Leverage

Funds themselves are increasingly using leverage. A key area of growth is NAV (Net Asset Value) financing, where a fund borrows against the value of its existing portfolio assets.
This is often used later in a fund's life to provide liquidity for distributions to LPs when exits are delayed. However, this practice increases the fund's leverage and interest burden without necessarily improving the underlying assets' value. NAV financing is considered riskier than traditional subscription lines because it creates a multi-layered leverage structure (the fund is leveraged, and its underlying assets are often already leveraged).

5. Interconnectedness and Implications for Japan

The paper concludes by emphasizing the growing integration of PE and PD markets with the broader financial system.

Global Links: Insurers and pension funds are major investors. A recent trend is fund managers acquiring insurance companies to use their assets for investing in their own funds.
Links to Japan:
- Institutional Investors: Japanese insurers and pension funds have increased their allocations to PE and PD as part of their alternative investment strategies.
- Major Banks: Japanese megabanks are actively providing fund-level financing (both subscription lines and NAV financing) to earn fees and secure related business, such as M&A advisory and underwriting for portfolio companies.

This deepening interconnectedness means that a shock in the global PE/PD markets could be transmitted to Japan's financial system. The BOJ concludes that the performance, credit quality, and systemic links of these funds warrant careful and continuous monitoring.