Is Private Credit Hiding More Risk Than It Shows?
According to the IMF’s Global Monitoring Report, the private credit market reached $2.1 trillion in assets by 2023—more than doubling in size since 2015. With attractive income potential and what looks like minimal correlation to traditional markets, it’s no surprise that private credit has gained attention among allocators seeking steady returns during uncertain times.
But beneath the surface, risks may be underestimated. This article looks at whether private credit is as stable as it appears—and what investors should weigh before adding it to a portfolio.
Key Takeaways
- Private credit yields can be compelling—but come with liquidity constraints and limited pricing transparency.
- Valuations are typically model-based, not set by open market activity, which can obscure risk during stress.
- Redemption gates and lock-ups make it difficult to exit during downturns.
- Apparent diversification may break down when markets are under pressure.
What Makes Private Credit Attractive?
Private credit refers to direct lending arrangements outside of traditional banks—ranging from senior loans and mezzanine financing to bespoke structures. These loans often yield 8–10%, and in some cases 12–14% with moderate leverage, significantly outpacing investment-grade corporate bonds.
Because private credit doesn’t trade on public exchanges, it avoids daily repricing. This can give the appearance of stability—net asset values (NAVs) often move slowly, especially when compared to publicly traded debt.
However, that smoothing is not necessarily a sign of strength. It may reflect valuation lags or assumptions that don’t hold up when credit conditions deteriorate. The next section explores the consequences.
What the Surface Doesn’t Show: Liquidity and Transparency Gaps
Unlike exchange-traded bonds, private credit investments are not readily sellable. Most vehicles come with 1–3 year lockups, and during periods of instability, redemption restrictions (or “gates”) can limit investor access to funds.
This creates a dangerous feedback loop:
- Investors see low volatility and assume stability
- Market conditions worsen
- Redemption requests spike
- Managers halt withdrawals
- Liquidity dries up—just when it’s needed most
Valuation methods compound the issue. Without regular market pricing, fund managers often rely on proprietary models or assumptions. In calm environments, this process goes unnoticed. But when conditions shift, these assumptions may delay recognition of real losses.
- Hypothetical: Consider a private credit fund lending to mid-market industrial borrowers. A slowdown hits. Defaults begin to rise. Yet the fund’s NAV barely budges—because it’s updated quarterly using internal models. Investors interpret this as resilience and stay invested. By the time risks become visible, exits are blocked.
Changing Credit Quality, Delayed Visibility
Borrowers in private credit markets are often small, non-rated firms unable to tap public bond markets. Many carry significant leverage. In a low-rate environment, this risk was easier to overlook. As rates rise, however, debt servicing becomes more challenging.
S&P Global Ratings forecasts the U.S. speculative-grade default rate to hit 4.5% by early 2025, up from around 1.6% in 2021. Many private credit borrowers fall into that speculative category. And because the asset class lacks standardized benchmarks and real-time pricing, investors may underestimate credit risk.
- The takeaway: private credit holdings might appear lower-risk on paper—but that perception may not hold when defaults rise.
Correlation Isn’t Always Low When It Matters Most
Private credit is often pitched as a diversifier—uncorrelated to equities or bonds. This is true in some environments, largely because valuations don’t fluctuate daily. But in periods of crisis, that advantage can disappear.
During the 2008 financial crisis, structured credit saw rapid declines as liquidity evaporated. In 2020, many private credit funds faced a surge in withdrawal requests—prompting some to impose gates or markdown NAVs.
The pattern is clear: when markets seize up, correlation across asset classes can rise dramatically. As the saying goes, "You don't know who's swimming naked until the tide goes out."
Yield Chasing Can Cloud Risk Perception
Private credit isn’t inherently unsafe—but its marketing often emphasizes returns without equal attention to hidden risks. This creates behavioral traps:
- Return-chasing: Allocating heavily based on recent performance.
- Complacency: Sticking with allocations despite changing credit or rate environments.
- Overconfidence: Interpreting smoothed NAVs as a sign of real safety.
These behaviors can lead investors to underestimate how fragile their liquidity position might be in a stressed scenario.
A basic yet critical question—“Would I be able to redeem during a crisis?”—often offers more insight than a glossy performance chart.
