The investment story of 2025 may already belong to private credit. You’ve probably heard about it – from your adviser, stockbroker, neighbour, or simply from its domination of AFR headlines.
There’s a long history of irrational exuberance for particular asset classes, and it rarely ends well. Bitcoin notwithstanding.
Of course, there’s more nuance to the private credit conversation than what’s offered by its loudest critics or its most passionate supporters.
This article will explore the asset class in more detail – what it is, the range of investments on offer, and whether it deserves a place in your portfolio.
What Is Private Credit?
Private credit is essentially lending that happens outside traditional sources like banks or listed debt instruments (e.g. corporate or government bonds).
A private credit fund manager might make hundreds (or even thousands) of these loans and package them into an investment fund, where investors earn a return from the interest payments.
The yields, i.e. the interest rates on offer, are typically higher than those available in standard bond funds. That higher return signals higher risk.
Private credit often fills the gap for borrowers who, for various reasons, can’t access traditional lending. That might be due to their risk profile, a lack of collateral, tight lending criteria, or simply a need for more flexible terms.
At first glance, private credit looks like a simple way to earn higher yields. Albeit with a higher risk of default, supposedly mitigated by diversification.
What Really Is Private Credit?
Contrary to much of the sales speak, private credit can simultaneously be far riskier than portrayed, while also offering a relatively poor return for the risk taken.
Private credit shouldn’t be seen as a consistent or homogenous asset class. Just as equities range from blue-chip companies like CBA down to speculative mining stocks, private credit spans a similarly wide spectrum.
There are certainly fund managers offering private credit products with fair compensation for the risks involved, sensible liquidity terms, and reasonable fees. But as the asset class has surged in popularity, so too has the number of newly minted managers marketing substandard offerings – often to retail investors.
These funds frequently offer a higher yield than their more established peers, but a closer look often explains why. Many are heavily concentrated in loans to property developers, issued at double-digit interest rates. The bankruptcy rates in that sector does not make for comforting reading.
Managers often attempt to justify this risk by pointing out that they hold a first mortgage over the development. This sounds reassuring until you consider that, in the event of default, that “security” may amount to nothing more than a block of land and a half-finished building. The result is often a liquidity crunch, where the fund is forced to sell the asset quickly – usually at a steep discount to another developer.
The other common defence is diversification – claims that thousands of loans spread across borrowers mitigate the risk. That may hold true in stable times, but development lending is prone to deep default cycles, particularly among inexperienced borrowers. It doesn’t take many defaults to cause serious liquidity issues within the fund, and in such cases, investors could see redemptions suspended for years and suffer meaningful capital losses.
To make matters worse, some of these funds carry egregious fee structures. A loan book yielding 12% might only return 8-9% after fees, meaning an investor could achieve a similar return elsewhere with much less risk.
Why Is It So Popular Now?
Private credit is enjoying its moment in the sun. With volatility returning to traditional bond markets, investors and advisers have been drawn to the seemingly stable, high yields on offer. On paper, it looks like the perfect mix – regular income, low volatility, and little correlation to equity markets.
But much of that perceived safety is marketing spin.
It’s often sold as a defensive asset, positioned slightly above the risk of a standard bond fund. In practice, however, private credit is highly correlated with equities during periods of stress. Why? Because the real risk in private credit lies in borrower defaults – and those defaults tend to spike during the same economic downturns that impact equity markets.
In other words, this is not a bond-like investment where you’re simply collecting coupon payments until the end of the term. The final return of capital is far from guaranteed, and in many cases, the “security” attached to the loan may not be worth much in a worst-case scenario.
Private credit might not show daily volatility like shares, but that doesn’t mean the risk isn’t there. It’s just hidden – until it isn’t. In a liquidity crunch, investors may be unable to exit, and valuations can quickly fall once defaults begin to materialise.
Its popularity, then, is built on a misunderstanding: that it offers equity-like returns with bond like risk. In truth, many private credit funds offer equity like risk (or greater) with slightly better returns than bonds, and that’s before fees are accounted for.
Now, of course, not every private credit fund looks like the ones described above. Some of the more well-managed options do provide access to relatively low-risk, diversified credit portfolios with reasonable fee structures. Naturally, because the risk is lower, so are the returns – often in the range of 7%, or around 3% above the RBA cash rate.
Still, this remains a complex and opaque part of the investment universe. It requires someone with the expertise to properly assess the true risk of the portfolio, rather than relying solely on the marketing material provided by the fund manager.
The Risks
Risk in terms of investment is so often equated with volatility. Shares are volatile, and therefore they’re riskier. Yet, if one held a broad market index fund for about 30 years, there is zero historical precedent for investment loss.
For equities, provided that the investment is not sold, capital should be protected over time, losses only occur when the investment is sold too early. With debt investments like private credit, the risk is different. A loan that defaults doesn’t recover. Losses can be sudden, permanent, and unrecoverable.
Here are the key risks to be aware of:
Default Risk
This is the most obvious and applies to individual loans within the fund. The borrower fails to repay, and the fund loses capital. Defaults are rare in good conditions but can spike in downturns – especially if lending standards are weak or overly aggressive.
Liquidity Risk
Most private credit funds don’t offer daily withdrawals. Investors may be locked in for long periods, especially during market stress when redemptions are paused.
Manager Risk
Outcomes vary widely depending on the fund manager. Poor underwriting, excessive concentration, or chasing yield can greatly increase risk. This would be hard to evaluate prior to making an investment without experience in this area.
Valuation Risk
Loans are not marked to market. They’re often held at model-based values that change slowly, even when risks are rising. Early investors may exit at inflated prices, leaving later investors exposed when the fund is eventually revalued.
Transparency
Many private credit funds provide limited visibility into their loan book. Without clear disclosures, investors may not know what risks they’re actually taking.
Final Thoughts
Private credit is not a new asset class – but the way it is being marketed recently should cause some concern. Especially for those in the business of ensuring their clients understand their investments and the risks being taken.
It should be obvious by now that a new breed of private credit managers has emerged – keen to downplay risk and talk up yield, all while charging egregious fees. Too often, the products they’re selling are filled with the proverbial excrement of the lending world: risky loans to borrowers that couldn’t meet a bank’s most lenient lending standards.
These managers exploit the widespread belief that debt investments are inherently safer than equities. This is a misnomer. Just because a fund doesn’t bounce around in daily valuations doesn’t mean it is lower risk. In some cases, these structures are far riskier than shares, not because of volatility, but because of the genuine possibility of permanent capital loss.
To the uninitiated, private credit can sound sophisticated, or even exclusive. In reality, the loans inside many of these funds are anything but. Few well-run, financially sound businesses would willingly borrow at 14% interest. If someone is paying that much, there’s usually a reason, and it’s rarely a good one.
The most important principle behind debt-based investments is that in order to achieve a higher yield, more risk must be taken – one way or another. Ergo, if you’re receiving an above-average return from your private credit investment, you can be sure there’s additional risk in there somewhere, even if you can’t see it yet.
