Private credit, explained

What is private credit? 

Private credit refers to loans made to companies by nonbank lenders, typically through privately negotiated agreements rather than public bond markets. These loans are not traded on exchanges and are often extended to midsized or “middle‑market” businesses that may be too small, too complex, or too specialized for traditional bank financing. 

On the risk‑return spectrum, private credit sits between public fixed income and private equity. Investors are compensated primarily through income, not ownership stakes, and accept lower levels of liquidity than public credit offers in exchange for greater structural protections and (potentially) higher yields. Investors tend to incur higher costs to access private credit than for bond mutual funds or ETFs. 

How does the private credit market work? 

Private credit strategies are typically executed through pooled investment vehicles that raise capital from investors and deploy it to portfolios of loans. Portfolio managers source deals directly, negotiate terms with borrowers, and typically hold loans through maturity. 

Key characteristics include: 

• Direct origination. Lenders work one‑on‑one with borrowers rather than buying securities in public markets. 
• Customized terms. Loan structures may include collateral, floating interest rates tailored to each deal, and covenants, or financial rules that the borrower needs to follow while the loan is outstanding. 
• Active oversight. Managers monitor their loans on an ongoing basis, and the renegotiation of loan terms can be part of the return equation, often due to growth or stress in the borrower’s business. 

Illiquidity is a feature, not a bug, of private credit investing  

Private credit investments are not designed for frequent trading. Capital is typically locked up for years, valuations are reported periodically rather than daily, and investors’ ability to sell their fund interests is limited. 

This illiquidity is intentional. Investors who can commit capital for longer periods may earn an illiquidity premium—additional compensation for giving up ready access to their money. For suitable investors, that trade‑off can make private credit a differentiated source of income within a broader portfolio. For others, the lack of liquidity can make private credit unsuitable. 

Private credit versus high‑yield bonds 

A modest portion of private credit loans goes to investment-grade borrowers. Most private credit loans are unrated or below investment grade.  

Here are key differences between private credit and high‑yield bonds, which also help finance below-investment-grade borrowers: 

• Market structure. High‑yield bonds trade publicly; private credit loans do not. 
• Liquidity. High‑yield bonds can generally be bought and sold daily; private credit cannot.  
• Diversification. The exposures that private credit and high-yield bonds have to various industries—and thus their risks—differ significantly. For example, software companies historically have accounted for a larger share of the private credit market than for the high-yield bond market.  
• Pricing and volatility. Private credit valuations tend to be smoother, reflecting infrequent pricing rather than daily market moves. 
• Control. Private lenders often have more influence over borrowers through covenants and direct relationships. 

The result is a different risk profile—one that is distinct from public credit markets. 

Private credit and investor suitability 

Private credit is not a substitute for traditional bonds, nor is it appropriate for every investor. To capture the potentially higher returns and diversification benefit of private credit (or other private assets), investors should have sufficient risk tolerance, long time horizons, adequate sources of liquidity, and access to high-performing managers. 

 

_Notes:  

_{All investing is subject to risk, including possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.} 

_{Investments in bonds are subject to interest rate, credit, and inflation risk.} 

_{High-yield bonds generally have medium- and lower-range credit-quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit-quality ratings.} 

_{Private investments involve a high degree of risk and, therefore, should be undertaken only by prospective investors capable of evaluating and bearing the risks such an investment represents. Investors in private investments generally must meet certain minimum financial qualifications that may make it unsuitable for specific market participants.}  

_{Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility.}