As regulatory changes and market dynamics continue to reshape the lending landscape, private credit has grown in sophistication and scale as a core asset class within private investments.

Private credit presents a complex yet rewarding avenue for those seeking to diversify income streams and enhance portfolio resilience. It can be an attractive addition to a portfolio beyond public equities and fixed income.

This article discusses the following:

• What is private credit?
• Why is private credit growing?
• Is there a private credit bubble?
• Benefits of adding private credit to your portfolio
• Potential opportunities in private credit
• How to approach private credit investing

What Is Private Credit?

Private credit refers to non-bank lending. Loans are made directly to companies or borrowers from sources that typically include debt financing from institutional funds or managed pools of private capital.

Private credit isn’t traded, doesn’t get rated by credit agencies and is illiquid in contrast to public fixed income.

The concept of liquidity is central to comparing public and private credit markets. Liquidity measures the ease of converting an asset or security into cash along with how easily financial assets can be bought or sold without severe price changes.

Similar to traditional fixed income, private credit primarily derives returns from interest income, typically with a floating rate instead of a fixed interest rate.

Traditional Fixed Income Securities Versus Private Credit

Traditional fixed income securities are publicly syndicated, rated on a standardized scale, and sold, whereas private credit is privately originated, unrated and held.

Segments of private markets offer a unique sponsor-lender relationship. The originator of private credit is inherently more involved during the lifetime of the contract, whereas public fixed income relies on the largest shareholders to step in during times of financial difficulty.

Additionally, certain areas of private markets offer structural seniority through asset coverage, that can potentially limit downside risk if credit deteriorates. The common types of private credit include:

• Senior direct lending. Secured loans made directly to middle market companies, with priority in claims against assets of a business to other debt and equity that the company may issue.
• Junior debt. Direct loans that are subordinate to senior loans but above equity.
• Mezzanine debt. Junior debt that contains elements of debt and equity, expectations of higher returns given the increased risk and lower status on the capital stack.
• Distressed debt. Lending to or active management of existing loans to borrowers that are insolvent or in financial distress.
• Specialty finance. Lending for unique business or asset situations such as equipment leasing, music royalties, asset-based finance.

Characteristics of Private Credit Versus Public Credit

Characteristics of private credit include:

• Non-bank lending
• Illiquid; infrequently priced and traded if at all
• Privately originated and held within a fund or funds the originator manages
• Originating firm has a close relationship with borrower and an ability to assist in times of financial stress
• Pays interest with floating rate mechanisms

Characteristics of public credit include:

• Public lending
• Liquid; may be priced and traded daily
• Publicly syndicated and sold to numerous institutional and retail investors
• During times of financial stress largest debtholders have to collectively work together with the borrower if at all
• Pays interest at a fixed rate

Why Is Private Credit Growing?

The driving factors of growth in private credit have come from both supply and demand.

Supply Growth Factors

Growth within private credit can be largely attributed to the increased regulatory environment for banks after the 2007–2008 global financial crisis (GFC). As banks have stepped away from certain investing spaces, private credit stepped in to fill the void.

This is largely due to private credit not sharing the same restrictive capital requirements, given the lending is sourced from invested capital versus being based on banks’ balance sheet and deposit requirements. Private capital tends to have more control over the terms and profile of capital requirements.

Demand Growth Factors

Private credit also facilitates one-to-one relationships for ongoing issues as opposed to a syndicated public bond issuance. The originator is typically one specialized asset manager working directly with the borrower, as opposed to a bank selling an entire bond issuance and the responsibility for ongoing financial concerns falls in the hands of numerous investors with no identified leadership of that syndicate.

Client allocations to private credit have increased as new opportunities for individual investors to gain access are being developed. This has also increased the private capital available. A key driver of this development is technology and new investment platforms designed to reduce the operational challenges of offering alternative investments, removing the roadblock of high minimum investment requirements.

Businesses are seeking funding with:

• Easier origination processes
• Lower costs to entry
• Flexibility
• Ongoing relationships with credit specialists

Is There a Private Credit Bubble?

While there may be a bubble in headlines, there doesn’t appear to be one in the asset class itself.

As discussed, an increase in demand from businesses for alternative forms of capital has met an increased supply of funds from both traditional institutional investors as well as newer retail entrants.

Businesses can secure capital for their business more quickly and at lower monetary and diligence costs. When appropriate for the investor and they understand the increased risks, investors in direct lending seek to capture a higher yield that also floats, mitigates inflation risk and leads to higher potential returns.

Bubble Claim Origins

The loudest detractors of private credit are largely competitors to the space. This could include traditional banks, asset managers, or financial advisors.

Traditional Banks

Given the post-GFC capital requirements, traditional banks are limited in their capacity to provide this type of lending. Losing out on this opportunity comes with a loss of revenue and the alternatives investment banks provide, such as public capital markets. Access to traditional underwriting of equity or bond issuance is costlier and involves time-consuming processes.

Larger banks have recently pivoted to establishing their own private credit funds or work with experienced managers in this space in order to compete in the growing asset class.

Traditional Asset Managers

Traditional asset managers that don’t operate outside the public markets are at risk of loss of market share to alternative investments.

Whether it’s an institutional or retail client, diversification has moved outside of traditional asset managers so their slice of the portfolio could be smaller for their qualified investors.

Financial Advisors

Financial advisors who are’t educating clients on alternative investments like direct lending are at risk of  losing business to firms that do..

While the asset class isn’t necessarily new, it’s been redefined and seen significant growth over the past decade.

Growth in any market trend can invite bad actors and malfeasance, and private credit is no different from other asset classes in that regard. Understanding the differences and various approaches is key to avoiding blatant risks.

Benefits of Adding Private Credit to Your Portfolio

Benefits of private credit include enhanced returns, portfolio diversification, and lower volatility.

Enhanced Returns

Private credit could increase your portfolio’s return potential.

Illiquidity Premium

Investors will demand a higher return from private investments compared to their liquid counterparts as a premium for illiquidity and risks.

In addition to the nominal premium, private credit features floating rate mechanisms, which mean the overall yield would rise in inflationary environments, offering some inflation protection.

Other Unique Strategies

Private credit can sometimes offer the potential for excess returns through unique strategies.

Public credit issuance tends to be straightforward. Debt is issued from a company’s balance sheet based on the cash flows, accounting performance, and other economic measures, and is traded on the public markets.

Private credit can take many forms and originates in various situations because the lending practices aren’t as regulated as traditional bonds or bank lending. For example, distressed debt investments can provide access to opportunities not found in public markets.

Allocation to leveraged loans, smaller companies, different variations of seniority or debt structure, and illiquidity equates to higher risk premiums than the public market. It’s important for investors to fully understand the unique risks of this asset class before incorporating them into a portfolio.

Diversification

The inclusion of private credit can increase diversification by providing exposure to different or less correlated sources of return. For example, the addition of direct lending adds a different kind of fixed income return—floating rate debt versus fixed rate debt which is what’s typically held in 60/40 portfolios.

These two strategies work together as floating debt benefits as rates rise while fixed rate bonds decline in price in that scenario.

Lower Volatility

Adding private credit to your portfolio can provide lower correlations with traditional asset classes, potentially reducing overall portfolio volatility. Lower volatility also largely means less liquidity, thus understanding your short- and long-term liability needs is important in planning for this lack of liquidity.

Potential Opportunities in Private Credit

Alternatives offer investors an opportunity to enhance portfolio performance through alpha, diversification, and income.

There are several specific opportunities in 2025 for individuals looking to expand their portfolio into private credit investing, including the following.

Direct Lending

Direct lending is the most common form of private credit investing, specifically within high-quality middle market companies, and can be an attractive space for private credit investing.

Middle market businesses borrow money from private credit fund managers based on financial performance and forecasted expectations. The borrowing terms feature a fixed spread over a floating benchmark lending rate. Given the ease of access for businesses and the excess returns of this space, it can be an attractive option that avoids taking on the excess risk in credit quality.

Distressed Debt

Distressed debt can have a return opportunity given the credit cycle in the mid-2020s, and impacts of interest rate hikes.

With a sharp rise in interest rates, certain business and asset backed loans decrease in value due to economic and interest rate stresses. Often, valuations can fall well below what is justified or reasonable. This creates opportunities for private credit fund managers to take stakes in these assets and help influence or lead a turnaround of the asset, with the goal of selling at a premium.

In contrast to other private credit investing return profiles, which primarily derive their return from yield, distressed debt returns come from capital appreciation.

Distressed debt is considered more opportunistic than direct lending because the success is based on a downturns in credit cycles. Distressed debt also carries a larger amount of risk given the majority of the return is based on capital appreciation from the turnaround of the businesses’ financial circumstance versus interest payments like public bonds or direct lending.

How to Approach Private Credit Investing

When exploring private credit investments, it’s important to consider that each asset class has its own unique risk profile.

The asset class comes with:

• Complex fee structures
• Various fund structures
• Wide variance in accessibility options

Private Credit Fund Structures

Private credit can be accessed through different vehicles, including:

• Publicly traded credit equivalents
• Semi-liquid evergreen funds
• Illiquid draw-down funds
• Variations of the above

The various private credit fund structures also require different investor qualifications, such as accredited investors or qualified purchasers.

An investor would want to assess their comfort level with the risks, illiquidity and the impact of the fund structure on your return.

For example, public market equivalents may be more liquid with similar underlying holdings. However, they may correlate much more to public markets based on sentiment, versus the underlying performance of the assets.

Manager Selection Is Paramount

Public market funds, whether debt or equity, tend to have similar exposure to greater market indices for their respective asset classes. This leads to tighter correlation in performances by public managers since the composition of their funds will be fairly similar.

In private credit funds, the observations of performance have a greater dispersion due to the unique nature of the underlying holdings. Selecting appropriate managers with long tenure, extensive credit experience, and positive track records is imperative.

Risk Tolerance

 It’s important for investors to understand that private credit may not be right for their risk tolerance, despite the draw to potential enhanced returns. Within these investments there’s increased illiquidity, risks, and, as with any investment, the risk of loss of principal. With private credit issuers, there’s also an increased risk that the issuers and counterparties will not make payments on securities, repurchase agreements, or other investments, creating defaults that result in losses. Additionally, the credit quality of securities within the investment may be lowered if an issuer’s financial condition changes, and may lead to greater volatility in its pricing, and may affect liquidity.

Any investor considering investing in alternative investments such as private credit should have comfort and clarity around the risks before investment.

Allocation Planning for Illiquidity

Given the illiquid nature of private credit and private credit markets, an investor needs to allocate in alignment with their future liquidity needs and spending goals.

Allocating in excess could lead to lack of principle accessibility and allocating too little could have a de minimis impact on the overall return.

Important Information

Investing in alternative investment strategies is speculative in nature and often carries a higher degree of risk than traditional investments and should only be considered by sophisticated investors with the knowledge and comfort to accept the loss of all or part of their investment in such strategies.

We’re Here to Help

For more information about incorporating private credit in your portfolio, please contact your Moss Adams professional.

Additional Resources

• Private Clients Practice
• Wealth Management Services