Introduction

There has been much discussion about private credit recently in the Australian market, with one large advice group removing these funds from their approved product list. Elsewhere, research houses have put the sector “on watch.” That is always the prerogative of an advice group or research house; however, we take a more constructive view of the sector and feel that these funds can play an important role for investors.

Private credit offers appealing returns, portfolio diversification, and the benefit of insulation from rising interest rates thanks to its typically floating-rate exposure. As with any asset class, however, exposures should be appropriately sized relative to the returns received, the risk undertaken, the liquidity, and the correlation with other asset classes. Private credit may be a much smaller allocation in portfolios than traditional fixed-interest exposure, depending on the portfolio strategy.

A sector on the rise

The asset class has gained significant traction over the past 15 years, driven by market conditions such as low interest rates and investor demand—particularly for its floating-rate exposure when bond yields were at low levels. Investors felt there were inflation risks, and rising interest rates would hurt traditional fixed-interest returns. Its growth is also underpinned by regulatory changes that compelled banks to pull back from lending to certain segments, in turn creating a crucial financing gap.

corporate debt markets

Source: EY Debt and Capital Advisory, Australia Capital IQ, LoanConnector, and Bloomberg APRA ADI Reporting as of Dec. 31, 2023.

It has also garnered attention from the regulators. The Australian Securities and Investments Commission has stepped up its oversight of private credit funds. In its discussion paper launched in February 2025, the corporate regulator flagged its concerns on private credit: “We are also concerned about the private credit market. While it does not appear to be systemically important in Australia, failures are on the horizon, and at current volumes, it is untested by prior crises.”

Transparency and oversight are always welcome, particularly as some market participants remain wary of private credit in uncertain economic climates. However, high-quality funds may be well-equipped to manage challenges like borrower defaults or economic downturns. By choosing private-credit managers with proven expertise and strong processes, investors can unlock the full potential of this asset class.

However, as with any financial product, understanding the risks and intricacies is crucial.

What is private credit?

Private credit involves nonbank entities offering loans directly to businesses that may not have access to traditional financing channels. These loans often align with private equity ventures, providing financial support and growth capital to businesses owned or controlled by private equity firms.

Private credit financing can range from bilateral arrangements (loans with a single lender) to syndicated financing where multiple lenders collaborate with fund borrowers. The flexibility of private credit makes it a vital resource for businesses struggling to secure bank financing, especially given regulatory changes in the banking sector following the global financial crisis.

With an estimated AUD 200 billion in private credit funds under management in Australia alone, this market has matured significantly. Major players like Metrics Credit Partners, overseeing AUD 23 billion in funds, showcase the broad reach and growing influence of private credit in the global economy.

Key features and benefits

Floating-rate exposure

Unlike traditional fixed-interest investments, private credit often provides floating-rate exposure. This feature acts as a hedge against rising interest rates, as floating rates ensure returns adjust to the market. Investors benefit from higher yields without the negative impact of rate hikes on capital value.

Attractive returns

Private credit funds frequently offer returns that exceed those of traditional fixed-income investments. Funds often target returns of cash plus 3% per year or higher, which can be akin to equity like returns for these fixed-income allocations.

Portfolio diversification

An allocation to private credit can improve portfolio diversification, in turn enhancing risk-adjusted portfolio performance.

Flexible strategies and protections

Private credit managers employ diverse techniques to protect investors, such as negotiating covenants with borrowers, securing senior positions within the capital structure, and utilising workout solutions if borrowers default. These measures can mean that private credit funds are well-equipped to manage economic turbulence.

Challenges

While the opportunities in private credit are immense, they are accompanied by significant challenges that investors must consider carefully.

Limited liquidity

One of the most notable drawbacks of private credit funds is their low liquidity. Unlike traditional mutual funds, investors cannot access their capital immediately, making private credit less suitable for those prioritising liquidity in their portfolios. Morningstar is soon to release its global methodology for researching illiquid, or “interval” funds.

Transparency issues

Transparency remains a key concern in the private credit market. Many private credit funds do not provide detailed information about their holdings, often because of client confidentiality, making it harder for investors to assess risks and returns. Morningstar emphasises the importance of full transparency to allow for proper risk assessment and decision-making.

Manager skill

Success in private credit relies heavily on the expertise of fund managers. Skilled managers not only structure effective lending agreements but are also adept at executing loan workouts and navigating distressed situations. For example, in cases where borrowers face financial difficulty, managers may restructure loans, take equity positions in a business, and implement turnarounds to recover capital.

Due diligence is key

Thorough due diligence forms the foundation for successful private credit investing. When evaluating a private credit fund, the following factors are key:

Parent and people expertise: It’s important to assess the manager’s ability to source new deals, their networks and relationships, and their sectoral/industry knowledge. Considerations include:

  • What commercial, legal, and regulatory resources does the team have access to in assessing potential transactions?
  • Is there a skilful and experienced investment committee in place to assess new proposals?
  • Are high-quality credit underwriting standards in place?
  • Does the team have the ability and a process to price loans relative to risk?
  • When loans go bad, do they have skills and experience in restructuring troubled loans?
  • Does the manager have access to other due-diligence resources such as industry databases and tools?
  • Are these “off the shelf” or proprietary?
  • Is the team incentivised in a way aligned with the underlying investors in the funds

Investment process: Ensure the fund has robust processes for diversification and risk management, such as limiting exposure to specific sectors or borrowers. For example:

  • Are the liquidity profiles of the underlying investments well-suited to the risk profile of the overall fund?
  • Are the redemption processes suitable?
  • How do portfolio managers decide on the appropriate asset and sector allocation within the funds, along with the maturity profiles of the loans?
  • Are these staggered in a balanced way?
  • How does the manager conduct valuations of the security underlying a loan?
  • Are independent third parties used for these assessments?
  • Are they skilled at credit analysis of the underlying businesses?
  • Does the manager have a healthy deal pipeline?
  • Are loans structured in a way to protect the underlying investors via either capital structure or covenants to trigger control of the equity of the borrower’s businesses?
  • Can holdings be liquidated in secondary markets or to network partners?
  • How are portfolios monitored and managed on an ongoing basis?
  • What are the fee structures on the underlying loans and the overall fund

Transparency: Verify that the fund discloses sufficient details about its underlying holdings and decision-making processes. Effective due diligence can help identify private credit managers with the capability to deliver strong returns throughout a market cycle.

A core component in portfolios

Private credit represents a dynamic and evolving sector, with immense potential to provide attractive returns, portfolio diversification, and inflation protection. However, investors must weigh these benefits against the challenges of liquidity constraints, borrower default risk, and transparency issues. For those willing to commit to thorough due diligence, private credit offers a powerful tool for navigating stable or rising-rate environments and achieving equitylike returns from fixed income. The sector’s growth and innovation signal its potential to remain a core component of modern portfolio construction.

Investors should approach private credit conscientiously, focusing on quality managers and well structured funds to maximise benefits in the face of economic uncertainty.

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