What Is Private Credit, and Does It Belong in Your Portfolio?

Private credit is lending done outside the public bond market and outside traditional banks: investment funds make loans directly to companies, usually mid-sized businesses often owned by private equity sponsors, and investors receive the interest. The asset class has grown rapidly, with assets under management estimated to exceed $2 trillion in 2026 (Mordor Intelligence), and it attracts investors because senior secured direct lending has recently offered yields meaningfully above comparable public credit, with estimates of the premium commonly in the range of 150 to 300 basis points, averaging around 200. That premium is compensation for real risks, not a free improvement over bonds. Investors give up liquidity, accept borrowers that are typically smaller and more leveraged than public issuers, rely on valuations that are estimated rather than observed in a market, and pay a fee stack that consumes part of the yield. Whether it belongs in your portfolio depends on whether you have return-seeking capital you can truly commit for years, and whether you can access competent managers.

How does private credit work?

The basic transaction is simple. A company needs to borrow. Rather than issuing a public bond or taking a syndicated bank loan, it borrows directly from one or a small group of private credit funds. The fund holds the loan, collects interest, and passes the income to its investors after fees.

Most private credit is direct lending, which accounted for the majority of the market in recent years, and most direct lending is senior secured and floating rate. Senior means the loan sits at the top of the borrower's capital structure and is repaid before subordinated debt and equity. Secured means it is backed by collateral. Floating rate means the interest resets with a reference rate, so the loans carry relatively little interest-rate duration, which is materially different from a traditional bond portfolio and is part of the appeal.

The borrowers are typically middle-market companies, frequently owned by private equity firms financing an acquisition. This matters: the credit quality of the asset class is tied to the health of leveraged, sponsor-owned businesses.

Where does the yield premium come from?

Understanding the source of the premium is the key analytical question, because a premium with an identifiable cause is more durable than one that simply exists.

Part of it is an illiquidity premium: lenders demand more to hold an asset they cannot readily sell. Part is a complexity and origination premium, since these loans are privately negotiated, require underwriting capability, and are not commoditized. Part reflects speed and certainty of execution, for which borrowers pay. And part is plain credit risk: these borrowers are generally smaller, more leveraged, and lower rated than public investment-grade issuers.

That last component deserves emphasis, because it is often understated in marketing. A yield advantage that exists because the borrower is riskier is not an advantage at all until it survives a default cycle. The relevant comparison is not private credit yields against investment-grade bonds, but private credit against high-yield bonds and leveraged loans of similar credit quality, where the gap is narrower.

What are the real risks?

Five stand out, and current conditions make several of them more than theoretical.

Credit and default risk.Default measures have been rising. Proskauer's Private Credit Default Index reported a 2.73% default rate in the first quarter of 2026, up from 1.84% two quarters earlier, though it eased to 2.51% in the second quarter. Fitch Ratings measured a U.S. private credit default rate of 5.8% for the twelve months through January 2026, the highest since it began tracking the figure in August 2024, a short history that is worth keeping in mind. Estimates differ substantially by methodology, which is itself informative. Bank of America's credit strategists have been reported as characterizing private credit as the lowest-quality asset class within their leveraged finance coverage (Forbes, May 2026). The asset class has grown enormously during a benign period and has not yet been tested by a severe, prolonged downturn.

Illiquidity.Capital is typically locked for years in closed-end structures. Semi-liquid vehicles such as interval funds and non-traded business development companies offer periodic redemptions, but those redemptions are capped, commonly at around 5% of the fund per quarter. The distinction matters: an interval fund must make its repurchase offer, while a non-traded BDC's repurchases are at the board's discretion and can be reduced or suspended precisely when many investors want out at once. Liquidity that disappears under stress should be treated as illiquidity.

Valuation opacity.Loans are not traded on an exchange, so values are estimated using models and manager judgment rather than observed prices. This can understate true volatility and delay the recognition of deterioration. The Financial Stability Board's 2026 report on private credit vulnerabilities specifically identified valuation opacity, along with bank interconnections, concentration and liquidity mismatches, and data gaps.

Manager dispersion.The gap between skilled and unskilled underwriters is far wider than in public fixed income, where an index fund captures most of the available return. In private credit, manager selection is the dominant driver of outcomes, and access to the best managers is limited. This makes it an asset class where doing it poorly is materially worse than not doing it.

Fees.Management and incentive fees, plus fund-level expenses and in some structures leverage costs, absorb a meaningful share of gross yield. The yield that reaches you is what matters, and the marketed gross figure is not it.

Who should consider it, and how much?

Private credit is a candidate for the portion of a portfolio that is return-seeking and can be committed for years without disruption. In our framework, that is capital in the Lifetime or Legacy horizons, never money needed for near-term spending, which belongs in the Liquidity allocation described in goals-based asset allocation.

Reasonable prerequisites include sufficient overall wealth that an illiquid allocation does not constrain your life, the ability to meet capital calls and hold through a full credit cycle, access to truly institutional managers rather than whatever product is being distributed most aggressively, and a clear-eyed view that this is a credit allocation, not a bond substitute. Sizing should be modest relative to the total portfolio, and the allocation should be diversified across managers and vintage years rather than concentrated in a single fund launched in a single environment.

It is a poor fit for investors who might need the money, who are attracted primarily by a headline yield, who cannot access quality managers, or who would be substituting it for the safe, liquid portion of their portfolio. Treasuries and other cash instruments serve a different purpose entirely, as discussed in cash management for wealthy families.

What diligence questions matter?

The same discipline we apply to any alternative investment applies here, and it is covered more broadly in alternative investments for private wealth and the private markets primer. The questions specific to private credit include: What is the manager's loss and recovery history through prior cycles, not just recent yield? What share of loans are senior secured versus subordinated? How concentrated is the portfolio by borrower and industry? How are loans valued, how often, and by whom? What is the fund's leverage? What are the all-in fees, and what is the net yield after them? For semi-liquid vehicles, what are the redemption terms and what happened to them in past stress? And how much of the portfolio consists of payment-in-kind arrangements, where borrowers pay interest in additional debt rather than cash, which can mask deterioration.

A worked example: gross yield versus what you keep

The following is a hypothetical illustration. A fund markets a 10.5% gross yield on a senior secured direct lending portfolio.

Subtract a management fee of roughly 1.25% and an incentive fee on income, plus fund expenses, and the net yield to the investor might be closer to 8%. Then assume a default rate of 3% of the portfolio in a given year with a recovery of 60%, producing credit losses of about 1.2%, which brings the realized net return nearer 6.8%. Compare that with a liquid high-yield bond alternative and the premium narrows considerably, while the investor has accepted multi-year illiquidity and valuation opacity to earn it.

The point is not that private credit fails this comparison. In many periods and with strong managers it clears it. The point is that the honest comparison is net of fees and net of credit losses against a similar-risk liquid alternative, not gross yield against investment-grade bonds. The figures are hypothetical and illustrative only.

Frequently asked questions

What is private credit in simple terms?It is lending outside the public bond market and traditional banks. Investment funds make loans directly to companies, typically mid-sized and often private-equity owned, and investors receive the interest income in exchange for accepting illiquidity and credit risk.

Is private credit safer than stocks?It sits higher in the capital structure than equity, which helps in a default, but it is not a safe asset. Borrowers are typically leveraged middle-market companies, and default measures have risen from earlier lows, ranging from roughly 2.5% to 5.8% depending on methodology during 2026.

How much yield premium does private credit offer?Estimates commonly place senior secured direct lending roughly 150 to 300 basis points above comparable public credit, averaging around 200 basis points, with the wider measures drawn against broadly syndicated loans. That premium compensates for illiquidity, complexity, and credit risk, and it must be evaluated net of fees and losses.

Can I get my money out of a private credit fund?Usually not on demand. Closed-end funds lock capital for years. Semi-liquid interval funds and non-traded BDCs allow periodic redemptions, commonly capped near 5% per quarter. Interval fund offers are mandatory, but non-traded BDC repurchases are discretionary and can be reduced or suspended when many investors seek liquidity at once.

Should private credit replace bonds in my portfolio?Generally no. High-quality bonds and cash serve a stability and liquidity function that private credit does not, because it carries meaningful credit risk and cannot be sold readily. It is better viewed as a return-seeking allocation than as a fixed income substitute.

What is the biggest risk people overlook?Valuation opacity combined with an untested cycle. Because loans are marked using models rather than market prices, reported volatility can understate real risk, and the asset class has grown enormously without yet facing a severe prolonged downturn.