CPD: The private credit zeitgeist

Investors are increasingly allocating to private debt markets to insulate against volatility.

Private credit has been the topic de jour, with new funds being launched regularly over the past two to three years. What’s behind the sudden rise in the number of funds and its popularity as a growing segment of alternative investments?

Private credit refers to non-bank lending. Instead of borrowing from a bank or issuing bonds on a public exchange, a company gets a loan from a private lender, such as a private credit fund or an institutional investor. It encompasses privately negotiated debt instruments extended to corporate borrowers.

Operating outside the regulated banking system, private credit serves as a capital source for privately held or non-investment grade companies. It encompasses a broad spectrum of investment strategies beyond direct lending, offering diverse opportunities for investors. Key types of private credit include:​

• Direct lending – provides loans directly to middle-market companies, often filling the financing gap left by traditional banks.
• Mezzanine debt – a hybrid of debt and equity, mezzanine debt is typically unsecured and subordinated to senior debt, offers higher interest rates and potential equity conversion options.
• Distressed debt and special situations – investing in the debt of companies that face financial challenges, but with the potential for significant returns through restructuring or turnaround efforts. ​
• Specialty finance – involves securitising pools of collateral, for example aircraft financing or music royalties, and bundling these assets to sell in the private credit market. ​
• Real estate credit – provides loans secured by real estate assets and offers exposure to property markets without direct ownership. ​

These instruments are typically illiquid, carry varying degrees of credit risk and are often customised to meet the specific capital structure or liquidity needs of the borrower.

Public credit versus private credit

In public credit markets, financing a leveraged buyout (LBO) for example, would typically involve a major bank underwriting a substantial loan, often ranging from $600 million to over $5 billion. The bank then syndicates this loan by selling portions to numerous institutional lenders, such as fund managers, insurance companies and superannuation funds.

This process results in a large syndicate where each lender holds a share of the loan. Public credit markets are characterised by their transactional nature, allowing these syndicated loans to be bought and sold among investors. This provides liquidity and enables active trading.

In contrast to public credit markets, private credit operates in a distinct environment, primarily focusing on financing smaller, middle-market companies through non-bank institutions. Typically, these deals involve businesses with earnings before interest, taxes, depreciation, and amortisation (EBITDA) between US$40 million and US$60 million.

Private credit generally offers greater flexibility and expedited closings, as banks are not involved. The borrower – be it a corporate or private equity sponsor – benefits from knowing the exact composition of the lending group and gains assurance that these lenders will retain the loan throughout its duration, avoiding the public market’s requirement for public ratings and the complexities of syndicated loans. This structure ensures a more streamlined and predictable financing process in the private credit space.

Growth in the private credit sector

Industry-led research^[1] indicates that the global private credit market passed the US$3 trillion milestone in late-2024. Respondents were optimistic about further growth prospects in core US, European and Asian private credit markets. This growth has made private credit available a differentiated asset class for Australian investors.

The most significant expansion in private credit began after the Global Financial Crisis (GFC), particularly around 2009. A key driver was the retreat of traditional banks from certain types of lending. Faced with stricter regulatory requirements around leverage and capital adequacy, banks began pulling back from financing leveraged buyouts and other riskier lending activities. This created a significant gap in the market – one that private credit managers were well-positioned to fill. While this type of lending existed before, the volume and scale increased dramatically in the post-GFC environment.

Another major catalyst was the growing preference of private equity firms for private credit over the syndicated loan market. This is because private credit offers greater execution certainty, involves fewer counterparties and aligns well with the long-term, relationship-driven approach favoured by private equity managers. This has made private credit a more attractive option for sponsors seeking efficient and flexible financing solutions.

The expansion of private credit into new asset classes also played a meaningful role. This includes asset-backed financings such as pools of home improvement loans and aircraft financing – areas that were not traditionally part of the private credit universe but have grown rapidly in recent years. Together, bank retrenchment, private equity demand and asset class diversification have fuelled the robust growth of the private credit market.

Private credit growth is expected to continue in the years ahead, largely driven by a significant gap in “dry powder” – capital raised but not yet deployed – between private equity sponsors and private credit managers.

Another key driver of growth in the private credit market is the vast untapped potential – or “white space” – in US direct lending. The US middle market, surprisingly the third-largest economy globally behind the US and China, consists of over 200,000 businesses generating more than $10 trillion in revenue. Yet, only about 10 percent of these companies are currently backed by private equity sponsors, leaving significant room for future investment. Additionally, private credit in the US middle market has grown over 26 times, far outpacing the 2.7 times growth of the US public market cap, highlighting the sector’s rapid expansion and long-term potential.

Why invest in private credit?

Including an allocation to private credit in portfolios can help enhance returns, manage risk and diversify away from public markets, especially important given today’s evolving macroeconomic landscape.

Private credit offers several compelling benefits that make it an attractive addition to a diversified portfolio:

• It provides consistent income, often through monthly distributions, which appeals to income-focused investors.
• It delivers risk-adjusted total returns by offering premium yields while maintaining a senior secured position in the capital structure, reducing downside risk.
• Private credit offers interest rate protection through floating-rate loans, which adjust with base rates like the Secured Overnight Financing Rate^[1] (SOFR), helping investors navigate interest rate volatility.
• It contributes to diversification and low correlation with traditional asset classes such as fixed income and equities, enhancing portfolio resilience.
• It aids in volatility management, as private loans are valued by independent third-party firms based on credit fundamentals, not market sentiment, resulting in more stable pricing.

Importantly, private credit has historically delivered strong yields and maintained a significant return premium over syndicated and high-yield bonds, while experiencing lower default rates and higher recovery rates.

Private credit opens the door to private market lending and bespoke financing deals not available in public markets, which adds another layer of portfolio depth. Loans are typically secured and senior in the capital stack; this offers downside protection and improved recovery prospects in the rare event of default. Overall, private credit combines high income, low volatility and strong downside protection, making it a robust alternative investment.

What to look for in a private credit manager

When assessing private credit managers, there are several key factors you must consider, to ensure you select a strong and reliable partner as stewards of your clients’ capital.

1. Evaluate the manager’s experience and track record, particularly how they’ve performed through economic cycles and at challenging times such as the GFC and COVID.
2. Understand their investment strategy – do they focus on the lower, traditional or upper middle market? Each segment has a different risk and return profile.
3. How do they source their deals? Managers with strong relationships, particularly with private equity sponsors, are more likely to access high-quality, proprietary opportunities.
4. Scale and presence in the market matter too, as larger managers often have better access, broader resources, and deeper insights. For example, Churchill Asset Management manages over $50 billion in committed capital.
5. Assess the health of the manager’s current portfolio, including non-accrual rates and watchlist exposure, as well as the presence of a dedicated workout team to manage any distressed assets.
6. People are important and team stability and firm culture are crucial; after all, the investment team is the core asset of any credit platform.
7. Understand the fund structure. Is it open- or closed-ended, levered or unlevered? Structure can significantly impact liquidity, risk and returns.

Private credit in 2025

At the beginning of 2025, the US Federal Reserve had seemingly orchestrated a soft landing: interest rates were lower and inflation had fallen. Most economists and market commentators believed the US economy’s persistent strength would keep rates higher than markets expected through 2025.

However, 2 April 2025 – ‘Liberation Day’ – introduced a new set of uncertainties for the global economy. Despite this – and the geopolitical tensions in the ascendent – private capital’s active management style and long-term investment horizons should offer investor portfolios shelter, diversification and added resilience in the face of current and future risks.

A recent survey by Churchill Asset Management found that investors are increasingly allocating to private debt markets to insulate against volatility: 20 percent said this was a main reason for investing in private credit, up from six percent in 20221 (figure one).

In this uncertain environment, the team at Churchill Asset Management believes four main tenets should underpin successful private credit managers:

• Maintain discipline when capitalising on what looks set to be a strong vintage. That means sticking to the strategies that have historically made them successful and investing based on fundamentals and cash flow generation. It also means being prepared to walk away if a deal does not make sense and, for those that do, allowing for a margin of error in earnings and valuations, while building in multiple ways out.
• Build all-weather portfolios that perform well regardless of external conditions. Diversification is an essential element here for all private credit investors – diversifying by industry sector, position size, deal structure, leverage profile, sponsor relationship and company model are all critical. Successful managers will also be constructing their portfolios for a different, less buoyant, environment, running detailed performance sensitivity analysis according to a variety of scenarios.
• Be active and proactive capital providers that support value creation in the businesses they back, while also being prepared to course-correct on existing investments when necessary. Experience and lessons learned help investors see round corners to identify potential opportunities and pre-emptively strike as new risks emerge. Decisiveness will win out in a fast-moving market.
• Work with trusted partners who have been through cycles and are closely aligned. Lenders and sponsors with strong relationships can work collaboratively through good and bad times to build and protect value in the portfolio.

Private credit represents a powerful and increasingly important asset class for your clients’ portfolios. As you seek to build resilient, income-generating and diversified portfolios for clients, private credit offers a compelling combination of attractive risk-adjusted returns, regular income through floating-rate structures and lower volatility compared to traditional public markets. Its low correlation to equities and bonds, alongside strong historical performance, even through challenging economic cycles, makes it a valuable diversifier.

With growing demand from private equity sponsors and a significant amount of untapped opportunity in the US middle market, the private credit space is poised for continued expansion. For advisers looking to deliver long-term value and stability to clients, allocating to high-quality private credit managers should be a strategic consideration within a well-rounded investment approach.

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Notes:
[1] Alternative Credit Council, Financing the Economy 2024, November 2024
[2] The Secured Overnight Financing Rate is a benchmark interest rate used in the US and reflects the cost of borrowing cash overnight

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