Fresh rate hikes from the U.S. Federal Reserve are pushing the already struggling private equity industry into even more dangerous territory. A record $349 billion is trapped in so-called "zombie funds," exit channels remain clogged, and fundraising has sunk to multi-year lows — the severity of this crisis is intensifying as the rate curve moves upward.

The Fed's rate increase announced Wednesday directly undermines the private equity sector's hopes for a market recovery earlier this year. The industry had broadly expected newly appointed Fed Chair Warsh, nominated by Trump, to push for rate cuts, which had briefly revived deal activity. Instead, rates have risen rather than fallen. Approximately $500 billion in private funds currently in their seventh to tenth year of existence face the risk of failing to exit on time, likely expanding the scale of "zombie funds" further.

According to a report, the shock of the rate hike is multi-dimensional: borrowing costs for portfolio companies are rising, asset sales are becoming harder, software investments are being hit by artificial intelligence disruption, and the private credit business is also facing turmoil. Shares of major alternative asset managers such as Apollo, Blackstone, and KKR have fallen notably this month as rate hike expectations intensified. Apollo's co-president Scott Kleinman admitted that some managers who expanded rapidly over the past decade will have to scale back.

Record Zombie Fund Scale Signals Vicious Exit Cycle

The private equity industry's "zombie nightmare" is far from over. According to data from PitchBook, the amount of assets trapped in zombie funds — those whose holding periods exceed ten years without exits — has surged roughly 65% from the end of 2021 to the end of 2025. Investors' urgent demand to reclaim capital has reached a record $349 billion.

The private equity business model relies on completing the "buy-grow-exit" cycle within about ten years: managers use their own capital as a base, raise funds from institutional investors like pensions and insurers, acquire companies while layering on leverage loans borne by the target, and ultimately sell to cash out, repay loans, collect management fees, and return profits to investors.

Rising rates directly disrupt this logical chain. The floating-rate loan costs of portfolio companies climb in tandem with benchmark rates, while potential buyers are unwilling to pay the valuations private funds demand when financing costs are high, making deals difficult to close. Since the 2022 rate hikes, the pace of selling portfolio companies has slowed significantly; this renewed increase will push more funds into the "zombie zone."

Mitchell Mansfield, a managing director at Kroll, said: "You will see more funds enter zombie status. The longer these funds exist, the more investor capital returns tend to stagnate, and then decline."

Fundraising Winter Deepens, Pressuring Manager Consolidation

Exit blockages directly transmit to the fundraising end. Private equity fundraising this year is heading toward its worst level since at least 2020. According to PitchBook data, as of September 11, the industry has raised $211.9 billion this year; full-year 2025 fundraising totaled $334.4 billion, down from $376.9 billion the previous year, marking a clear downward trend.

Institutional investors are tightening their commitments. Angela Rodell, former CEO of the Alaska Permanent Fund and now a senior advisor at Star Mountain Capital, said investors will "only renew relationships with specific firms they have confidence in, which will cause more private funds to shut down."

The average return for private equity funds in 2025 was about 7%, the weakest performance since 2011, even as the U.S. economy overall grew strongly. Declining returns make it harder for pensions, insurers, and endowments to meet their funding targets, and capital locked in funds that cannot be withdrawn for reinvestment further aggravates this dilemma.

Scott Kleinman, Apollo's co-president, said bluntly at a Monday analyst meeting: "I do think the number of managers will decrease, and some managers who expanded rapidly over the past decade will have to shrink." He also noted that Apollo continues to attract investors because its recent fund returns beat the industry average.

Software Investments Hit Hardest, AI Disruption Compounds Rate Pressure

Beyond rate hikes, private equity faces another pressure: heavy bets on the software sector made during the low-rate era over the past decade are now colliding with AI-driven disruption. According to PitchBook data, private equity firms allocate on average about 14% of their capital to software companies, with a large concentration of deals struck between 2020 and 2021 during the rate trough.

As loans backing these acquisitions mature, defaults are expected to cluster in the coming year and through 2028. Thoma Bravo has already lost $5 billion on its investment in customer service software firm Medallia this year — the company was taken over by lenders after defaulting. Thoma Bravo is now negotiating loan extensions with debt investors for other software holdings, including cybersecurity firm Sophos.

Clearlake Capital faces similar strain. The Santa Monica, California-based firm used its technology investment expertise to grow assets from roughly $8 billion in 2017 to $185 billion, but some software bets have hit headwinds.

Regulatory filings from private credit funds show that lenders have cut valuations by more than 30% each on a $2.1 billion loan to human resources software company Cornerstone OnDemand and a roughly $1.5 billion loan to healthcare software firm Symplr Software. Clearlake is negotiating solutions with loan holders on both facilities.

Anant Kumar, a portfolio manager at Benefit Street Partners, said: "In the long run, if high rates persist, these companies will face greater cash pressure and default with higher frequency."

Private Credit Business Feels the Squeeze, Industry Ecosystem Faces Reshaping

Private credit, another core business for private equity managers, is equally exposed to this round of rate hikes. Persistently higher rates will throw the private credit market into turmoil, further eroding managers' overall revenue streams.

Currently, private equity funds control more than $2 trillion in assets in the U.S., and their stress is transmitting to the broader financial system, affecting pensions and insurers that depend on exit proceeds from private funds.

Sara Werner, a partner at law firm Lowenstein Sandler, said: "Saying the golden age of private equity will never return is absurd, because markets are cyclical. But the question is how long these funds can wait for the valuations they want."

Analysts suggest that the spiral of expanding zombie funds → rising fundraising difficulty → declining management fee income → accelerating industry consolidation is becoming clearer as rates climb once again.