Understanding private credit
What is private credit and where does it fit in a portfolio?
Private credit is an asset class that offers investors seeking a source of income beyond stocks and bonds a distinct way to put capital to work. The asset class is built around lending: private funds provide capital directly to businesses, and investors earn returns through the interest on those loans. Like with all alternative investments, private credit comes with a set of unique strategies, structures and risks.
Private credit refers to loans made by non-bank lenders directly to businesses or individuals, typically outside of public debt markets. Instead of issuing bonds or securing financing through traditional banks, borrowers access capital from private funds, institutional investors or specialized lenders.
Within private markets, private credit sits alongside asset classes such as private equity and venture capital, centering on lending and income generation through interest payments rather than value creation through investment in private businesses.
Private credit has grown as banks have reduced certain types of lending, creating space for private investors to provide capital in areas that may be underserved by traditional institutions.1
1 Federal Reserve FEDS Note, "Bank Lending to Private Credit" (May 2025)
How private credit can create value for investors
When you invest in private credit, you take on the role of the lender, earning returns through the interest payments borrowers are legally obligated to make. Those payments can be fixed for the life of the loan or floating, adjusting periodically based on market conditions. This is distinct from equity investing, where returns depend on the value of an ownership stake rising over time.
Structuring
Structuring terms such as covenants, collateral and repayment priority
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Origination
Origination advantages where managers source and negotiate proprietary deals
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Risk pricing
Risk pricing where less liquid or more complex loans may offer higher yields
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Active management
Active management including monitoring borrower performance and restructuring when needed
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Typical structure and mechanics of private credit
Private credit investments are often accessed through pooled investment vehicles such as private funds or interval funds. These structures allow managers to deploy capital across a portfolio of loans.
Capital commitments
Investors commit capital upfront, which is drawn over time as investments are made
Investment period and hold duration
Loans are typically held for several years, depending on maturity and repayment terms
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Limited liquidity
Investors generally cannot redeem capital on demand
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Role of the sponsor or issuer
Borrowers are often backed by private equity sponsors or are operating companies seeking growth or refinancing capital
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Distributions
Private credit distributions are typically made from interest income and principal repayments over the life of the investment. As borrowers make their scheduled interest payments, those proceeds are passed through to investors, regularly providing an ongoing income stream rather than a single payout at the end. When loans mature or are repaid early, the principal is also returned to investors, gradually restoring the original capital committed.
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Risk considerations
Private credit involves a distinct set of risks that investors should understand before allocating capital.
Illiquidity
Investments are not traded on public markets, and capital may be locked up for extended periods. Unlike stocks or bonds, there is no secondary market where investors can easily sell their position if circumstances change. As a result, investors should be prepared to have their capital committed for the duration of the investment, which can span several years.
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Credit risk
Borrowers may fail to meet interest or principal obligations. This can occur due to deteriorating business performance, unexpected market shifts, or broader economic stress. While loan structures and collateral can help mitigate losses, there is no guarantee that all capital will be returned in a default scenario.
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Structural complexity
Deal terms, covenants and capital structures can vary widely and require careful assessment. Each loan agreement may include unique provisions, such as maintenance covenants, payment priorities, or collateral arrangements, which can affect how risk and return are distributed. Investors should ensure they have a clear understanding of these terms, or rely on an experienced manager to evaluate them on their behalf.
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Time horizon and liquidity
Private credit investments are generally long-term in nature.
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Typical hold period
Several years to a decade, depending on the strategy. Capital is typically returned gradually through interest payments and amortization rather than in one lump payout.
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Liquidity profile
Limited; loans are privately negotiated and not broadly traded. Secondary markets may exist but can be thin or require discounts to exit. Capital is often returned gradually through amortization or at maturity.
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Secondary markets
Available but often constrained, with limited buyer pools and potential pricing discounts relative to par value.
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Exit events
Typically include full loan repayment at maturity, borrower refinancing, or sale of the underlying business. Each can trigger a return of capital to the investor, sometimes ahead of the scheduled term.
Investors should be prepared to commit capital for multi-year periods, with cash
flows that may be gradual rather than lump-sum.
Common private
credit strategies
Senior direct lending
Private REITs provide exposure to diversified real estate portfolios without public market trading.
Borrowers are generally cash-flow-generating companies, often backed by private equity sponsors
Loans are secured by business assets such as equipment or receivables and sit senior in the capital structure
Lenders are first in line to recover their investment if the borrower defaults
Specialized finance
Lending in niche areas such as venture debt, litigation finance or equipment leasing.
Borrowers range from early-stage startups to law firms and asset-intensive businesses
Collateral varies by strategy and may include intellectual property, legal claims or future revenue
Typically sits junior to senior debt, reflecting higher risk and the potential for higher returns
Asset-backed lending
Loans secured by specific collateral such as receivables, real estate or inventory.
Borrowers are companies or entities with significant tangible or financial assets on their balance sheet
The direct link between the loan and identifiable collateral provides a defined source of recovery
Generally holds a senior position in the repayment order, supported by the value of the underlying assets
Mezzanine and subordinated debt
Financing that sits between senior debt and equity in the capital structure.
Borrowers are typically established companies seeking capital for acquisitions, growth or recapitalizations
Collateral may be limited or secondary to senior lenders, with returns supported by equity-like features such as warrants
Subordinated position means higher risk than senior debt, with potential for higher returns to compensate
Distressed debt
Investing in obligations of financially stressed companies, typically at a discount.
Borrowers are companies facing operational or financial challenges, often in or near restructuring
Collateral and positioning depend on the specific instrument, which may range from senior secured to unsecured claims
Returns hinge on recovery outcomes, with significant upside if the borrower stabilizes or assets exceed purchase price
How private credit may fit into a broader portfolio
Private credit may play a role in a diversified portfolio by offering an income oriented complement to equity investments.
Income generation
Regular interest payments may support cash flow needs
Diversification
Returns may be less correlated with public equities and bonds
Risk profile
Positioned between traditional fixed income and private equity in terms of risk and return characteristics
Time horizon alignment
May be suitable for investors with longer investment timelines
How self-directed IRAs unlock access to alternative asset classes
For some investors, private credit can also be accessed through tax-advantaged structures such as a self-directed IRA. A self-directed IRA follows the same rules as standard IRAs, but allows for a broader range of investment options beyond stocks and bonds. Since retirement capital is already earmarked for longer-term use, it may naturally align with the timelines for private credit investments.
Key questions investors should ask
Before investing in private credit, investors may benefit from asking:
What types of borrowers and industries are included in the portfolio, and what credit quality do they represent?
What is the expected holding period, and what liquidity options are available during the investment period?
Where does this investment sit in the capital structure, and what protections are in place if a borrower defaults?
How are fees structured and how do they affect net yield?
How does the strategy generate income, and are returns fixed, floating, or a combination?
How is performance measured and reported?
