Private Credit Funds: An Essential Component of Modern Portfolios?
As investors navigate an increasingly complex market environment characterized by volatile public markets and persistent inflation concerns, private credit has emerged as a compelling asset class that offers potentially attractive risk-adjusted returns with lower correlation to traditional investments. Once the exclusive domain of large institutional investors, private credit funds are now increasingly accessible to individual investors through innovative fund structures.
What Exactly Is Private Credit?
Private credit refers to loans made to companies outside of public bond markets and traditional bank lending. These loans are typically negotiated directly between the lender (the fund) and the borrower (usually mid-sized companies), offering investors potential benefits not readily available in public fixed-income markets: higher yields, stronger covenants, and customized financing solutions.
The private credit market has experienced explosive growth, expanding from roughly $300 billion in assets under management in 2010 to over $1.2 trillion today. This growth has been fueled by banks retreating from certain lending activities after the Global Financial Crisis of 2007-2008, creating an ever increasing financing gap that private credit funds have eagerly filled.
The Private Credit Spectrum: Four Key Strategies
1. Direct Lending
Direct lending involves providing loans directly to middle-market companies, typically with EBITDA between $10-$100 million. Often these companies are owned by private equity funds, looking for highly flexible funding to enable the rapid scaling of that company. Direct lending loans are usually senior secured, meaning they sit at the top of the capital structure and are backed by company assets. Based on currently prevailing base rates, direct lending funds typically offer returns in the 6-9% range, net of costs and on an unlevered basis, with a relatively low risk profile.
2. Mezzanine Financing
Mezzanine debt sits between senior debt and equity in the capital structure. It typically offers higher yields (10-14% gross) but comes with greater risk. Additionally, these loans often include equity-like features such as warrants or conversion rights, providing potential upside beyond the stated interest rate. They can also be structurally subordinated to other debt, e.g. by lending to the holding company of a private equity owned company. Mezzanine financing is commonly used in leveraged buyouts, in which higher leverage levels are useful in boosting equity returns, and in growth capital situations.
3. Distressed Debt
Distressed debt involves purchasing the debt of companies experiencing financial distress, often at significant discounts to face value. This strategy may even focus on bankruptcy and restructuring processes, in which the risk on losses is significantly higher. However, returnscan also be more substantial (potentially 15%+), but are more volatile and dependent on successful turnarounds or favorable restructuring outcomes.
4. Specialty Finance
This category encompasses a diverse range of lending activities backed by specific assets: real estate debt, infrastructure financing, asset-based lending, and trade finance. These strategies offer varying risk-return profiles and are often characterized by strong collateral protection and contractual cash flows.
Why Private Credit Makes Sense Now
Attractive yields: Private credit typically offers a few-% premium over comparable public debt investments, compensating investors for reduced liquidity and complexity.
Inflation protection: Many private credit investments feature floating-rate structures that adjust upward as interest rates rise, providing a natural hedge against inflation.
Portfolio diversification: Private credit typically has lower correlation to public markets, potentially reducing overall portfolio volatility.
Regular income streams: Unlike private equity, private credit provides periodic interest payments, creating consistent cash flow for investors.
Evergreen Structures: Enhancing Private Credit Accessibility
Traditionally, private credit funds were structured as closed-end vehicles with 7-10 year lifespans, similar to private equity. However, the emergence of evergreen structures has dramatically improved accessibility for individual investors.
Private credit is an asset class that lends itself well for an evergreen structure:
Continuous deployment: Especially large fund managers have access to continuous dealflow, enabling rapid deployment whenever is necessary, matching the continuous inflows that characterize an evergreen fund.
Reinvestment potential: For non-distributing share classes, interest payments can be reinvested perpetually, enhancing the power of compounding returns over time and resulting in steeper value growth.
Improved liquidity: Because of the self-liquidating nature of private credit loans, and the relatively short tenors compared to VC or buyout private equity, investors are generally offered a high degree of liquidity, e.g. quarterly or even monthly.
Lower investment minimums: As private credit is growing quickly, many managers realize that the wealth segment will be important in unlocking more funding over the next decade. Therefore, more and more evergreen debt funds feature minimum entry tickets, as low as $50k, much lower than to the multi-million dollar commitments required for traditional private credit (closed-end) funds.
Key Considerations When Selecting Private Credit Funds
Manager Experience and Track Record
Unlike more efficient public markets, private credit success depends heavily on the manager's underwriting discipline, sector expertise, and relationship network. Look for managers with proven track records through multiple credit cycles and deep expertise in their target markets.
Credit Quality and Diversification
Losses on loans may significantly decrease net returns in private credit, and therefore it is critical to look for a large degree of diversification – in terms of single asset concentration, but also across geographies and verticals. However, such a degree of diversification is not always possible under a single manager. Investors should nonetheless seek to understand the fund's approach to credit risk: What industries do they target? What position in the capital structure do they occupy? How diversified is the portfolio across borrowers, sectors, and geographies? Higher yields often come with higher default risk, so ensure the risk-return profile aligns with your investment objectives.
Leverage Usage
Many private credit funds employ leverage to enhance returns, which is especially common in larger, American fund vehicles. The fund may be able to borrow more money based on the collateral of the loan portfolio, using the difference between the portfolio yield and the cost of the credit line to boost returns for the fund’s investors. Any type of leverage magnifies returns, and therefore increases the risks and volatility for investors. Investors should try to understand how much leverage a fund employs and how it might perform in stressed market conditions.
Fee Structure
Fee structures typically include management fees (as low as 1% for straightforward direct lending strategies to 2% for more risk-taking strategies) and performance fees (10-20% of returns above a hurdle rate, similar to private equity). These can significantly impact net returns
Notable Private Credit Funds for Individual Investors
Several established asset managers now offer private credit funds with accessibility features that make them suitable for sophisticated individual investors:
Key Considerations When Selecting Private Credit Funds
Manager Experience and Track Record
Unlike more efficient public markets, private credit success depends heavily on the manager's underwriting discipline, sector expertise, and relationship network. Look for managers with proven track records through multiple credit cycles and deep expertise in their target markets.
Credit Quality and Diversification
Losses on loans may significantly decrease net returns in private credit, and therefore it is critical to look for a large degree of diversification – in terms of single asset concentration, but also across geographies and verticals. However, such a degree of diversification is not always possible under a single manager. Investors should nonetheless seek to understand the fund's approach to credit risk: What industries do they target? What position in the capital structure do they occupy? How diversified is the portfolio across borrowers, sectors, and geographies? Higher yields often come with higher default risk, so ensure the risk-return profile aligns with your investment objectives.
Leverage Usage
Many private credit funds employ leverage to enhance returns, which is especially common in larger, American fund vehicles. The fund may be able to borrow more money based on the collateral of the loan portfolio, using the difference between the portfolio yield and the cost of the credit line to boost returns for the fund’s investors. Any type of leverage magnifies returns, and therefore increases the risks and volatility for investors. Investors should try to understand how much leverage a fund employs and how it might perform in stressed market conditions.
Fee Structure
Fee structures typically include management fees (as low as 1% for straightforward direct lending strategies to 2% for more risk-taking strategies) and performance fees (10-20% of returns above a hurdle rate, similar to private equity). These can significantly impact net returns
Notable Private Credit Funds for Individual Investors
Several established asset managers now offer private credit funds with accessibility features that make them suitable for sophisticated individual investors:
Coller Credit
With a focus on secondary credit opportunities, Coller Credit provides a unique approach to private credit investing. Their strategy involves purchasing existing private credit positions from institutional investors, often at attractive discounts. This approach combines elements of both private credit and secondary market transactions.
CVC CRED European Private Credit
CVC CRED European Private Credit focuses on senior secured direct lending to European mid-market companies. The strategy emphasizes capital preservation through careful underwriting and strong creditor protections, while still targeting attractive risk-adjusted returns.
M&G Corporate Credit Opportunities ELTIF
Structured as a European Long-Term Investment Fund (ELTIF), M&G Corporate Credit Opportunities provides access to a diversified portfolio of corporate credit. The fund blends traditional private credit with opportunistic investments in dislocated public credit markets, providing flexibility to pursue the best risk-adjusted returns across market environments.
Partners Group Private Loans SICAV
Since 2007, the Partners Group Private Loans S.A., SICAV-SIF - SUB-FUND I is focused on private credit investments. It primarily invests in senior secured and subordinated loans, as well as other debt instruments, aiming to generate risk-adjusted returns over the medium to long term.
Finding the Right Allocation
For most investors, private credit should represent a complementary allocation alongside other private market investments. Financial advisors often suggest allocating 30-50% of the private markets portfolio, or about 5-25% of a diversified portfolio to private credit, depending on an investor's risk tolerance, liquidity needs, and investment goals.
When building a private credit allocation, consider evergreen approaches that combine solid risk-returns with a good level of liquidity. Indeed, many evergreens now offer a level of liquidity that is not much of a compromise compared to public markets, even though any investment in private markets should be considered a long-term investment.
Conclusion: Private Credit as a Portfolio Cornerstone
As market volatility continues and the search for yield remains challenging, private credit offers a compelling opportunity for investors to enhance returns while potentially reducing overall portfolio risk. The growing availability of evergreen and semi-liquid structures means this once-inaccessible asset class is now within reach for many individual investors, and can be used to complement their exposure to private equity
Like all investments, private credit comes with its own unique risks and considerations. Manager selection, appropriate position sizing, and a long-term investment horizon are essential for success in this space. By taking the time to understand the nuances of different private credit strategies and fund structures, investors can make informed decisions about incorporating this increasingly important asset class into their portfolios.