Private credit is where the banks used to be.

In 2015, a family-owned manufacturer with ninety million dollars of revenue and twelve million of debt would have borrowed from two or three banks. Each bank kept part of the loan and sold the rest to the others. Today the bank probably arranges the loan and sells the whole thing to a private credit fund, and that fund may sit inside your portfolio. The lending did not disappear. It moved off bank balance sheets and into funds.

The move was caused, mostly, by regulation. After 2008, banks were required to hold more capital against corporate loans, which made mid-market lending less profitable for them. At the same time, pension funds and insurers needed yield and could not get it from government bonds. Money met the borrowers in the middle. The market is now close to two trillion dollars globally, up from roughly three hundred billion fifteen years ago.

What an investor owns in these funds is usually a first-lien, floating-rate loan to a private company, paying a spread of five to six percentage points over the base rate. The loan is not traded. The fund values it quarterly using its own models and, where possible, comparable transactions. That is not a scandal; it is how an illiquid asset gets priced. But it does mean the number on your statement is an estimate, and it will be smoother than the truth.

The record so far is good, and that is the problem. Defaults in private credit have run below the historical average for high yield, because the last fifteen years have been, with two short exceptions, a good time to lend. Most loans in these funds were written when rates were near zero and earnings were rising. None of this book has been through a real recession. The nearest test, in 2020, lasted eight weeks and was met with central bank support.

Three questions are worth asking before writing a cheque. Who is lending, and to whom: a fund lending against recurring software revenue is a different risk from one lending against dental practices or industrial equipment. How much of the interest is being paid in kind, in more debt rather than cash. And what the fund allows itself to do when investors want out: the open-ended vehicles that permit quarterly withdrawals are the ones where a wave of redemptions forces sales into a bad market.

We own these loans in moderation, generally ten to fifteen per cent of a growth allocation, in closed-end funds whose duration matches the underlying loans. We prefer first lien, hard assets, and borrowers whose cash flow we could explain to a client in one sentence. We avoid the largest, most competitive deals, where covenant protection has been negotiated away to win the mandate.

Six to nine per cent is fair compensation for tying money up for years and taking credit risk. It is not a better bank account. Read the fee schedule, ask what happens in a default, and size the position as though the illiquidity is real, because it is.