Private Credit 101: What It Is and Why It Matters in Today’s Market
This article was originally published on the PassivePockets Website.
Key Takeaways for Investors
Private credit (also called private debt) is lending by non-bank investors directly to companies and real estate borrowers, outside public bond markets.
The asset class has grown to roughly $2 trillion in AUM globally and is projected to reach $2.8 trillion by 2028 as banks pull back from middle-market lending.
Investors typically access it through private credit funds structured for accredited investors and qualified purchasers under Reg D.
Common strategies include direct lending, mezzanine, distressed debt, real estate debt, venture debt, and CLOs — each with a different risk and return profile.
Allocators are paying attention in 2026 because private credit can offer floating-rate income, contractual cash flows, and lower correlation to public markets — though it carries illiquidity, credit, and manager-selection risk.
This guide explains what private credit is, how it compares to public debt, and where it fits in a modern portfolio.
Private credit, also commonly called private debt, has emerged as a growing component of the global financial landscape. As traditional banking systems and public credit markets face challenges, private credit has stepped in to fill funding gaps, offering unique opportunities for both borrowers and investors. With the private credit market nearing $2 trillion in assets under management (AUM) and projected to grow further, understanding this asset class is essential for modern investors. This article will break down what private credit is, its types, its role in portfolios, and why it’s gaining traction today.
What is Private Credit?
Private credit refers to loans or other forms of debt financing provided by private entities, such as individuals, companies, or funds, rather than governments or public institutions. Unlike public debt, which includes government bonds and other securities traded in regulated markets, private credit is typically not traded on public markets and includes various forms such as direct lending, bridge lending, mezzanine financing, and distressed debt.
Private credit plays an important role in providing capital to businesses, especially those in the middle market or those in need of specialized funding solutions. It’s a growing asset class that offers alternative investment opportunities for investors who are looking for diversification and the potential for higher returns compared to traditional debt.
| Component | Description |
|---|---|
| Lenders | Non-bank investors — asset managers, BDCs, and private credit funds |
| Borrowers | Middle-market companies, commercial real estate sponsors, and sometimes consumers |
| Loan structure | Privately negotiated, typically floating-rate, and held to maturity by the lender |
| Investor access | Primarily Reg D funds offered to accredited investors and qualified purchasers |
“Private credit refers to loans or other forms of debt financing provided by private entities, such as individuals, companies, or funds, rather than governments or public institutions.”
Types of Private Credit
Private credit comes in many forms, each with unique characteristics and terms. Here are some key categories:
Direct Lending: These are loans provided directly to small and medium-sized enterprises (SMEs), often secured by assets. This type of lending bypasses traditional banks and offers more flexible terms to borrowers.
Mezzanine Financing: A hybrid of debt and equity, offering higher returns but with more risk as it does not sit in a senior position on the capital stack. It often includes equity kickers like warrants, which allow lenders to convert debt into equity if the borrower defaults.
Distressed Debt: This involves purchasing debt from companies in financial trouble at a discount, with the potential for high returns if the company recovers. This type of debt has historically been used by investors looking to gain control of a company through its debt.
Private Debt in Real Estate: Private debt in real estate refers to loans made to property owners outside of traditional bank channels, providing exposure to real estate without owning physical properties. These loans are typically short-term and used to finance specific projects or parts of real estate development. For those familiar with real estate equity investing, private debt in real estate represents a natural progression and an accessible entry point for investors. This approach allows investors to leverage their existing knowledge of real estate. They can benefit from the substantial returns and lower risk associated with private debt. To learn more, read our article on Why Savvy Investors Should Consider Private Debt in Real Estate
Venture Debt: Debt provided to early-stage startups, usually alongside venture capital investments. This type of debt helps startups extend their runway without diluting equity.
Peer-to-Peer Lending & Private Consumer Debt: Often digital platforms that facilitate loans between individuals or small businesses. These platforms offer an alternative to traditional bank loans and can provide higher returns to investors.
Collateralized Loan Obligations (CLOs): Structured finance products that pool various loans and issue tranches with different risk levels. CLOs offer investors exposure to a diversified portfolio of loans.
| Strategy | Capital stack position | Typical borrower | Return source |
|---|---|---|---|
| Direct lending | Senior secured | Middle‑market companies | Floating‑rate interest |
| Mezzanine | Subordinated | PE‑backed companies | Interest + warrants |
| Distressed | Varies | Stressed or restructuring borrowers | Discount‑to‑par recovery |
| Real estate debt | Senior secured | Commercial real estate sponsors | Floating‑rate interest |
| Venture debt | Senior secured | VC‑backed companies | Interest + warrants |
| CLOs | Tranched | Leveraged loan portfolios | Tranche‑level coupons |
What is Public Debt?
While private credit is a growing component of the global financial landscape, it exists alongside public debt. Public debt refers to debt securities that are issued in open markets and accessible to a wide range of investors. These include government bonds, corporate bonds, and high-yield (junk) bonds. Understanding the distinctions and interconnections between private and public debt is essential for investors seeking to diversify their portfolios.
“Public debt refers to debt securities that are issued in open markets and accessible to a wide range of investors.”
Key Differences Between Private and Public Debt
| Feature | Private Credit | Public Debt |
|---|---|---|
| Issuer | Private entities (e.g., individuals, companies, funds) | Governments, corporations, municipalities |
| Liquidity | Illiquid | Highly liquid |
| Customization | Tailored to borrower needs | Standardized |
| Access | Limited to institutional/accredited investors | Available to all investors |
| Risk-Return Profile | Higher risk, higher yield | Lower risk, lower yield |
Examples of Public Debt Instruments
1. Sovereign Debt
Definition: Issued by national governments to fund public expenditures.
Example: U.S. Treasury Bonds (T-Bonds), UK Gilts, Japanese Government Bonds (JGBs).
Performance: Over the past 20 years, U.S. Treasuries have delivered average annual returns of 4%-5%, with yields declining significantly during periods of monetary easing (e.g., post-2008 crisis).
2. Corporate Bonds
Definition: Issued by companies to raise capital for operations or expansion.
Example: Apple’s investment-grade bonds or the Dow Jones Equal Weight US Corporate Bond
Performance: The Dow Jones Equal Weight US Corporate Bond has an annualized return of 2.52% over the past decades.
3. Municipal Bonds
Definition: Issued by state or local governments to fund infrastructure projects.
Example: California’s municipal bonds for transportation projects or the S&P Municipal Bond Index
Performance: The S&P Municipal Bond Index has annualized return of 2.31% over the past decade.
4. High-Yield (Junk) Bonds
Definition: Corporate bonds with lower credit ratings offering higher yields.
Example: SPDR Bloomberg High Yield Bond ETF (JNK Index). Some of the companies with BBB- ratings or lower included in the ETF are Charter Communications, Tenet Healthcare, and Community Health Systems.
Performance: The JNK Index has an annualized return of 4.94% over the past fifteen years but has been prone to sharp declines during economic downturns.
Comparing Private Credit with Public Debt
Private credit and public debt serve different purposes and come with distinct risk and return profiles. Here’s a comparison using some common indices and investment instruments:
Morningstar Levered Loans Index (LSTA): This index tracks private credit to corporations, providing valuable insights into the performance of loans made directly to private companies. While it may not fully represent the entire private credit market, it serves as proxy that reflects private credit performance.
Bloomberg Aggregate Bond Index: Represents investment-grade bonds, providing a benchmark for bond performance. This index includes a wide range of high-quality bonds and is often used as a benchmark for fixed-income investments.
Corporate Bond: Debt issued by corporations, typically offering higher yields than government bonds but with more risk. Corporate bonds are a common way for companies to raise capital. An example is the Dow Jones Equal Weight US Corporate Bond, designed to track the total returns of 100 large and liquid investment-grade bonds issued by companies in the U.S.
JNK ETF: Tracks high-yield bonds, also known as junk bonds, which offer higher returns but come with higher risk. The volatility of junk bonds can be as high as equity investments. This instrument includes bonds from companies with lower credit ratings. (BBB- rating or lower)
“Private credit and public debt serve different purposes and come with distinct risk and return profiles.”
Here’s the past ten-year return for these indices.
The Role of Private Credit in Modern Portfolios
Private credit plays a crucial role in modern investment portfolios by offering several benefits:
Portfolio Diversification: Private credit can reduce overall portfolio risk through diversification. By adding private credit to a portfolio, investors can spread their risk across different asset classes and reduce their exposure to market volatility.
Stable Returns: Provides stable returns across market cycles, often with lower volatility compared to public debt. Private credit investments are typically less affected by market fluctuations and can offer more predictable income streams. As shown by the chart above, the Morningstar LSTA has exhibited less volatility during 2015, 2018, 2021, and 2022 compared to the other fixed income instruments.
Inflation Protection: Many private loans have floating interest rates tied to benchmarks like the Secured Overnight Financing Rate (SOFR), which adjust upward during inflationary periods, protecting investors’ purchasing power.
Historical Performance: Private credit has demonstrated resilience and strong performance during various stressed economic conditions. The chart below includes periods of high stress over the past 25 years, illustrating the performance of different fixed-income investments. Notably, an outlier occurred during the 2008 Global Financial Crisis (GFC), when the Morningstar LSTA index significantly underperformed due to its liquidity issues and perceived risk profile.
Why Investors Are Paying More Attention to Private Credit Today
Several factors are driving the increased interest in private credit:
Search for Higher Yield: The search for higher yield helps drive the demand for private credit. Private credit has many factors that allow it to generate higher yields than traditional public fixed income investments. Unique supply and demand characteristics, increased complexity, and lower market accessibility are just some of these factors.
Lower Volatility and Stable Returns: Private credit has garnered increased interest due to its ability to offer attractive returns in both high and low-interest rate environments. In a high-interest rate cycle, floating interest rates on private credit instruments help protect investors from interest rate risk and allow lenders to capture higher yields. Conversely, in a low-interest rate cycle, while public yields may compress, private credit often sees less compression. Lower interest rates can also create benefits by reducing default rates and stimulating economic activity, leading to increased deal flow. This adaptability and resilience make private credit an appealing option for investors seeking stability in various economic conditions.
Education and Availability: An increase in education and a more diverse universe of investment options in private credit have led to increased allocations from both retail and institutional investors as they seek to control risk and enhance returns.
Growth of Private Equity Synergies: The rise of private equity has fueled demand for complementary financing solutions like mezzanine loans and direct lending for leveraged buyouts (LBOs).
Watch our webinar on the Rise of Private Credit to learn more.
“The search for higher yield helps drive the demand for private credit.”
Macro-Economic Factors that Create Opportunity for Private Credit
Economic Slowdowns: Periods of low economic growth or recessions can lead to increased demand for private credit as businesses seek alternative financing sources when traditional banks tighten lending standards.
Interest Rate Volatility: Fluctuating interest rates can impact the cost of borrowing and lending. Private credit instruments often feature floating interest rates, which adjust to market changes, helping protect investors from interest rate risk.
Inflation: High inflation can erode the real value of fixed-income investments. Private credit, with its potential for higher yields and floating rates, can offer better protection against inflation compared to traditional fixed income.
Regulatory Changes: Post-2008 financial regulations have restricted banks' lending capabilities, creating a gap that private credit has filled. Ongoing regulatory scrutiny and changes can impact the availability and terms of traditional financing, making private credit a more attractive option.
Market Disruptions: Events like the COVID-19 pandemic disrupted traditional financial markets, leading to increased demand for private credit as businesses seek flexible and accessible funding.
Geopolitical Risks: Political instability and geopolitical tensions can create uncertainty in global markets. Private credit's lower correlation with traditional markets can provide a diversification benefit, helping mitigate risks associated with geopolitical events.
Conclusion
Private credit has evolved from a niche asset class to an essential component of diversified investment strategies, offering unique opportunities for portfolio diversification, consistent income streams, and potentially higher returns than traditional fixed-income investments. With increased educational resources, investors can better understand the various types of private credit and make more informed decisions. As the market is projected to grow to an estimated $2.8 trillion by 2028, now is an opportune time for investors to explore this dynamic asset class. Whether through direct lending, venture debt, or CLOs, private credit aligns with modern financial goals, providing stable income, portfolio diversification, and inflation protection. Investors should consider their risk tolerance and liquidity needs before diving into this complex yet rewarding space and consult financial advisors or experts when structuring their portfolios around this promising asset class.
Not sure if private credit is right for you? Take our short Private Credit Suitability Assessment: https://kirklandcapitalgroup.com/private-debt-suitability-assessment.
Frequently Asked Questions
Q: What is private credit? A: Private credit is lending by non-bank investors — typically asset managers and private credit funds — directly to companies or real estate borrowers, outside public bond markets. Loans are privately negotiated, generally floating-rate, and held to maturity by the lender.
Q: Is private credit the same as private debt? A: Yes. The terms are used interchangeably across the industry. "Private credit" is the more common usage in 2026 search and investor conversations; "private debt" is the older industry term. They refer to the same asset class.
Q: How is private credit different from private equity? A: Private equity buys ownership stakes in companies and earns returns through equity appreciation. Private credit lends to companies and earns returns through interest payments and principal repayment. Private credit sits higher in the capital stack — lenders are paid before equity holders if a borrower struggles.
Q: How big is the private credit market? A: Global private credit AUM has grown to roughly $2 trillion and is projected to reach approximately $2.8 trillion by 2028, driven largely by bank retrenchment from middle-market and small-balance commercial lending.
Q: What are the main types of private credit? A: The largest categories are direct lending (senior loans to middle-market companies), mezzanine debt (subordinated, often with equity warrants), distressed debt (loans to stressed borrowers at a discount), real estate debt (loans secured by commercial property), venture debt (loans to VC-backed companies), and CLOs (collateralized loan obligations). Each has a distinct risk and return profile.
Q: Who can invest in private credit funds? A: Most private credit funds are offered under Regulation D and are limited to accredited investors and qualified purchasers — generally individuals meeting income, net-worth, or investable-asset thresholds set by the SEC. Some interval funds and BDCs offer broader access.
Q: What are the risks of private credit? A: The principal risks are credit risk (borrower default), illiquidity (capital is typically locked for the life of the loan or fund), manager-selection risk (outcomes vary widely by underwriting discipline), and valuation opacity (loans aren't marked daily like public bonds). Returns are not guaranteed and investors can lose principal.
Q: Why is private credit growing in 2026? A: Banks have pulled back from middle-market and small-balance commercial lending under post-2023 capital requirements, leaving demand that non-bank lenders are stepping in to meet. Allocators are also drawn to floating-rate income and lower correlation to public markets in a higher-for-longer rate environment.
