Private credit still offers an attractive yield premium over broadly syndicated loans and many public bond markets, but the environment has become much more manager-dependent. Higher base rates have boosted all-in yields, while slowing economic growth and elevated financing costs are beginning to separate disciplined underwriters from managers that relied on benign credit conditions.
Here's how I would think about the main segments.
| Strategy | Opportunity | Primary risks |
|---|
| Direct lending | Strong current income, floating-rate loans, lender-friendly documentation | Credit losses if earnings weaken, refinancing risk, covenant-lite structures |
| Distressed debt | Ability to buy assets at discounts and participate in restructurings | Timing is difficult, legal complexity, prolonged workouts |
| Specialty finance | Access to niche assets (asset-backed lending, royalties, equipment, consumer, litigation finance, etc.) | Asset-specific risks, operational complexity, liquidity |
Direct lending
This remains the largest and arguably most institutional segment.
The positives:
- Floating-rate loans have produced double-digit gross yields in many cases.
- Banks have retrenched from middle-market lending.
- Private lenders can negotiate stronger documentation than broadly syndicated markets.
What matters today isn't simply coupon—it's underwriting discipline.
I would favor managers that:
- lend at moderate leverage (for example 4-5x EBITDA rather than stretching to 6-7x)
- focus on companies with recurring cash flow
- have meaningful equity cushions from sponsors
- actively monitor portfolio companies
Less attractive characteristics include:
- aggressive EBITDA adjustments
- payment-in-kind (PIK) income masking weak cash flow
- covenant erosion
- reliance on refinancing instead of deleveraging
Distressed
This strategy becomes attractive when defaults increase.
Potential opportunities include:
- discounted performing loans
- stressed credits with liquidity problems rather than broken businesses
- rescue financing
- post-reorganization equity
The challenge is that distressed investing requires:
- restructuring expertise
- legal resources
- patience
- ability to control outcomes
Many managers claim to be distressed investors but mainly purchase discounted loans without true restructuring capabilities.
Specialty finance
This is probably the area where manager skill matters the most.
Examples include:
- equipment finance
- aviation finance
- healthcare receivables
- asset-backed lending
- music royalties
- insurance-linked finance
- litigation finance
- consumer receivables
The attraction is that returns often come from specialized underwriting rather than broad economic beta.
However, each niche has unique risks:
- legal
- regulatory
- servicing
- collateral valuation
- operational execution
A specialist with decades of experience may have a substantial edge over a generalist.
Due diligence on managers
Institutional investors typically spend as much time evaluating the manager as the asset class.
1. Team stability
Questions include:
- How long has the senior investment team worked together?
- Have key professionals left?
- Who actually makes investment decisions?
- Is succession planning credible?
High turnover is often a warning sign.
2. Track record quality
Rather than focusing only on gross returns, I'd examine:
- realized versus unrealized gains
- performance through downturns
- default rates
- recovery rates
- vintage-by-vintage performance
A manager that has only invested since 2021 hasn't yet demonstrated how it handles a full credit cycle.
3. Underwriting process
I'd want to understand:
- required debt service coverage
- leverage limits
- downside stress testing
- industry concentration limits
- sponsor selection
- approval process
Strong managers often reject far more deals than they fund.
4. Portfolio construction
Important metrics include:
- average position size
- industry diversification
- borrower concentration
- sponsor concentration
- geographic exposure
- first-lien versus junior exposure
Excessive concentration can amplify losses.
5. Incentives
Questions include:
- How much GP capital is invested alongside LPs?
- Is compensation based solely on asset growth or on realized performance?
- Are incentive fees subject to appropriate hurdles and clawback provisions?
Alignment of interests is critical.
6. Operational capabilities
For private credit, servicing matters almost as much as origination.
I'd evaluate:
- workout teams
- restructuring experience
- valuation process
- independent pricing
- reporting quality
- risk management systems
Risks that concern me today
Refinancing risk
Many companies borrowed when rates were much lower.
As maturities approach, refinancing may occur at materially higher interest costs.
Earnings pressure
If EBITDA declines while interest expense remains elevated:
- leverage increases
- interest coverage falls
- defaults become more likely
Delayed recognition of losses
Private assets aren't marked continuously like public bonds.
That means reported volatility can appear artificially low, even if underlying credit quality has deteriorated. Appraised values may adjust more gradually than public market prices.
Liquidity mismatch
Private credit funds can appear stable because assets are held to maturity.
But if investors need liquidity unexpectedly, selling loans may be difficult or require discounts.
This is especially important for evergreen or interval fund structures that offer periodic redemptions while investing in illiquid loans.
Competition
As capital has flowed into private credit:
- spreads have compressed in some segments
- leverage has increased in certain deals
- documentation has weakened
Manager discipline becomes even more important when competition intensifies.
What I'd prioritize today
If I were allocating capital now, my preference would generally be:
- Senior secured direct lending with conservative leverage and experienced underwriting.
- Asset-based and specialty finance strategies where collateral and structural protections can provide downside support.
- Opportunistic distressed managers that have demonstrated restructuring expertise across prior credit cycles, especially if defaults rise and create more attractive entry points.
I would be more cautious with managers that emphasize yield above underwriting quality. An extra 100–200 basis points of current yield can be overwhelmed by even a modest increase in defaults or weaker recoveries. In private credit, preserving principal is often the largest driver of long-term returns, making manager selection and underwriting discipline more important than simply choosing the highest advertised yield.
