NEW YORK, March 3 (Reuters) - Blackstone's flagship private credit fund faced a surge in withdrawals in the first quarter, amid wider investor jitters about private credit and troubles at smaller rival Blue Owl Capital.    

The New York-based investment giant let clients pull a bigger than usual $3.7 billion from the $82 billion fund, known as BCRED, a filing showed on Monday. Adding $2 billion of new commitments left net withdrawals at $1.7 billion.

Blackstone's shares fell 8% to a two-year low on Tuesday after it said redemption requests totaled 7.9% of the fund, before recovering ground to close down almost 4% on the day.

The requests prompted it to lift its usual 5% redemptions limit to 7%, while Blackstone and its employees invested $400 million to allow all requests to be met, it said. 

Shares in its peers also fell, before recovering, on indexes that were lower due to conflict in the Middle East.

The $2 trillion private credit industry has grown rapidly over the past decade and been hit lately by questions over valuation and transparency, concerns about Blue Owl replacing client redemptions with promised payouts, and the exposures of some players last year to the bankruptcies of a U.S. auto parts supplier and a subprime auto lender.    

Wall Street lenders were also shaken on Friday by the collapse of UK mortgage lender Market Financial Solutions Ltd, reviving warnings of "cockroaches" in the booming industry.

The employees who invested in the fund were more than 25 senior leaders from across the firm, who contributed a total $150 million, a person familiar with the matter said. That was first reported by Bloomberg News.

PRESSURE BUILDS ON RETAIL-FACING CREDIT FUNDS

Funds such as BCRED, which are open to wealthy individuals, have come under particular strain. Like the fund Blue Owl is struggling to manage, it is a business development company that raises money and lends it to mid-sized companies.

JPMorgan analysts said this was the first quarter of outflows at BCRED, the largest of its kind that doesn't trade on the market, and a "significant expression of souring investor sentiment on direct lending".

Investment bank RA Stanger, which closely tracks alternative assets including private equity and private credit, said it "believes alternatives are beginning to enter a hairpin turn, with capital shifting away from private credit. We are now forecasting an approximately 40% year-over-year decline in BDC capital formation for 2026."

Stanger compared the shift to the drop-off in real estate funds for wealthy investors in 2023, when Blackstone blocked withdrawals from a fund in that sector.

Around 24% of Blackstone's $1.27 trillion assets under management come from wealthy individuals, a group investment firms have courted as lagging returns deter institutions such as pension funds.    

Blackstone President Jon Gray told CNBC that buying products which let retail investors take out money periodically means they are "trading away a bit of liquidity for higher returns". Institutions, who typically lock up cash for longer, "continue to allocate significant amounts to private credit," Gray said.

Blackstone said its approach to redemptions was driven by the fund structure, "not by any constraints on BCRED's liquidity".