Fixed income investing is traditionally associated with gilts and corporate bonds traded in public markets. These instruments provide relatively predictable interest payments when compared to equities and play a defensive role in portfolios, as a counterpart to equities typically used to drive growth.
With fluctuating yields, and continuing inflation and interest rate pressures, investors continue to look for alternative sources of income and returns.
Enter private credit.
This segment of private markets offers experienced investors access to a wide range of credit strategies, often with the potential for enhanced yields, diversification and resilience.
This article isn’t personal advice. If you’re not sure whether an investment is right for you, seek advice. Private market investments, including private credit are considered high-risk investments for experienced investors and should only form a small part of a diversified portfolio. If you choose to invest the value of your investment and any income from it will rise and fall, so you could get back less than you put in.
What’s private credit?
Private credit is the private markets equivalent of public fixed income – like gilts, bonds and treasury bills.
Instead of buying publicly-listed bonds, private credit funds loan directly to companies, or against real assets. These loans are typically held to maturity, with income generated through regular interest payments and repayment of the original amount at the end of the term.
Unlike public bond markets, private credit deals are generally negotiated directly between lender and borrower, often involving tailored structures and risk-sharing arrangements. This custom agreement allows investors to target specific return profiles and gain exposure to otherwise hard-to-access segments of the credit market.
Importantly, yields linked to these segments can potentially be higher. Of course, past performance is not a guide to future returns and the level of risk taken with these investments is also higher, more on that later on.
Why has private credit grown?
Private credit has expanded significantly since the global financial crisis.
From 2000 to 2023, the number of private credit funds rose from 49 to 685. As banks retreated from parts of the lending market due to tighter regulation, higher capital requirements and shifting priorities – private lenders stepped in to fill the gap.
This has created an opportunity for investors to access new lending markets. In return, they benefit from income streams that are more insulated from public market volatility.
As with most private market investments, private credit comes with its own set of risks investors need to understand.
These investments are generally illiquid, meaning they are not easily sold and often need a long-term commitment. The private nature of these deals also means there is less transparency compared to public markets, making it harder for investors to assess and monitor risk.
Additionally, borrowers in this space are often smaller or less established companies, which increases the risk of default, particularly during economic downturns.
Valuation challenges are another consideration, as private credit assets are not traded on public markets and may not reflect real-time market conditions. Funds may also have concentrated exposure to a small number of borrowers or sectors, amplifying the impact of any single default.
Key segments of private credit
Just as fixed income includes a range of instruments, private credit spans a spectrum of strategies. These vary by borrower type, loan structure, seniority, and underlying asset.
Direct lending
This is the most established and widely recognised form of private credit. Direct lending involves making loans to finance mergers and acquisitions (including private equity-funded buyouts) of companies, or directly to private companies to fund growth.
Senior loans – positioned at the top of the capital structure, senior loans are typically secured against company assets and offer lower risk and lower yield compared to other types of direct lending.
Junior and mezzanine loans – ranked lower than senior credit in priority for repayment (subordinated), these offer higher returns but more risk. They’re often used to enhance potential returns in leveraged buyouts.
The direct lending space is attractive for its combination of regular income, and structural protections that can be built into bespoke lending agreements.
Real asset lending
Private credit is also used to finance real assets like infrastructure and real estate. These loans are typically secured against physical assets, offering investors more collateral protection.
Infrastructure credit – loans to support long-term assets like wind farms, solar parks or transport networks.
Real estate credit – financing for commercial or residential developments, often with income linked to rental or lease flows.
These assets can produce stable and predictable cash flows, making them appealing for income-focused portfolios.
Opportunistic credit
These strategies lend to more complex or higher-risk situations, like companies undergoing operational turnarounds or emerging from distress. Some opportunistic credit funds may seek to convert loans into equity if performance improves, potentially capturing upside beyond income alone.
Return profile – higher yield, often with equity-like upside potential.
Risk profile – elevated, dependent on business recovery or asset repositioning.
Asset-backed finance
Asset-based lending is a business financing method that uses an asset owned by a business as security against a business loan.
The lenders evaluate assets like inventory, accounts receivable, property, or industrial equipment to determine whether a business is eligible for finance. Some lenders will even consider assets such as intellectual property like brands and patents, when making a lending decision.
Return and risk profile – diversified, granular pools of income-producing loans. Risks are relatively low in comparison to other private credit investments as securities are well diversified but can be susceptible to a broader rise in loan default rates.
What can investors expect?
The appeal of private credit lies in its income-generating capabilities and diversification benefits. Yields can be higher than those of comparable public bonds, reflecting the ‘illiquidity premium' and bespoke nature of the lending. This isn’t guaranteed and past performance isn’t a guide to future return.
Because private credit is less exposed to market volatility and sentiment shifts, its performance tends to be more stable and predictable than some other private market asset classes. Interest payments are typically fixed or floating rate, offering a degree of protection against rises in central bank interest rates.
Fees are structured similarly to other private market investments with management and performance components, but because there is less focus on operational asset management, fees are lower than, for example, private equity.
Liquidity and access
Like other private market strategies, private credit is generally illiquid. Funds often have multi-year investment periods and require capital to be committed for a full term. However, growing investor demand has led to the emergence of semi-liquid and open-ended private credit vehicles that offer greater flexibility.
The FCA suggests retail investors put no more than 10% of their total net assets in high-risk investments. We suggest high-risk investments, including private markets, are held for at least five to seven years.
Who is private credit for?
Private credit is suited to experienced investors seeking an enhanced income in a low-yield, comparatively low risk-premium environment for private markets. It offers exposure to parts of the economy that public markets cannot reach while also giving the potential to add a layer of shelter to a portfolio via diversification to low correlation assets.
With a range of private markets products now available to investors, including VCTs, investment trusts and LTAFs, investors can learn more about them and explore investment options with HL.