Private credit is lending that happens outside the public bond and bank markets: an investment fund or manager negotiates a loan directly with a borrower, and investors earn the interest that borrower pays. It exists because many companies want financing that banks and public markets do not always provide, and because investors want the income that direct lending can offer. It also carries less liquidity and distinct risks.
Key takeaways
- ▹Private credit is privately negotiated lending: loans that are not traded on public exchanges.
- ▹It can offer attractive income, often at floating rates, in exchange for reduced liquidity and direct credit risk.
- ▹Returns depend heavily on underwriting and manager selection; this is not a passive, risk-free asset class.
How private credit works
The mechanics are simple. A borrower, often a mid-sized company, needs capital. Instead of issuing a public bond or drawing a bank loan, it borrows from a private lender: a fund that pools investor capital. The lender and borrower negotiate the terms directly, the loan is funded, and the borrower pays interest over the life of the loan and repays principal at the end.
Investors in the fund earn their return from that interest. Because the loan is private, its terms (rate, covenants, collateral, maturity) are tailored to the specific deal rather than standardized for a public market.
Major forms of private credit
Private credit is not one thing. Direct lending (senior loans made directly to companies) is the largest category. Senior secured lending sits at the top of the borrower's capital structure and is backed by collateral, so it is repaid first in a default. Asset-based lending is secured against specific assets such as receivables, equipment or inventory. Specialty finance covers niches like consumer, litigation or royalty finance. Each form carries a different balance of yield, risk and collateral.
Private credit vs public bonds
The comparison is a set of trade-offs, not a ranking. Private credit's potential yield premium is compensation for illiquidity, complexity and direct credit risk, not evidence that it is safer or better.
Where returns come from
Most of the return in private credit is interest income, the coupon the borrower pays. Some strategies add origination or structuring fees, and floating-rate loans earn more when benchmark rates rise. A portion of the return can be thought of as a premium for accepting illiquidity and for the work of underwriting and monitoring each loan.
None of this promises an outcome. The stated yield on a private loan is what the borrower owes, not what the investor is guaranteed to receive; defaults and losses reduce realized returns.
Why seniority and collateral matter
In a default, not all lenders are equal. Senior lenders are repaid before subordinated lenders and equity holders; secured lenders have a claim on specific collateral. That ranking is often the single most important determinant of how much a lender recovers when something goes wrong.
This is why the terms 'senior secured' appear so often in private credit. They describe a position near the front of the repayment line, backed by assets. It reduces potential loss severity; it does not eliminate the risk of loss.
Why private credit has grown
Private credit has expanded from a niche into a major asset class. Two forces drove this. After the global financial crisis, tighter bank regulation pushed some lending out of banks and toward non-bank lenders. At the same time, institutional investors sought income and diversification beyond public bonds. The result was more borrowers seeking private loans and more capital available to make them. Growth also invites caution: rapid expansion can compress lending standards, which is one reason careful manager selection matters more, not less.
Key risks
The main risks are credit and default risk (borrowers may not repay); illiquidity (investors usually cannot exit quickly); valuation risk (private loans are marked periodically, not continuously); leverage (some strategies borrow to enhance returns, which magnifies losses); concentration (exposure to a sector or a few large borrowers); and manager-selection risk (outcomes depend on the lender's underwriting discipline).
These risks are interconnected. In a downturn, defaults can rise just as liquidity dries up and valuations come under pressure, which is precisely when investors most want to sell and least can.
Where private credit may fit in a diversified portfolio
For investors who can accept illiquidity, private credit can play an income role and can diversify away from the drivers of public stocks and bonds. It tends to suit long-horizon capital rather than money that may be needed soon. The size of any allocation is an individual decision that depends on liquidity needs, risk tolerance and the rest of the portfolio.
Private credit inside CDB
Within Compound Diversified Bond, private credit is a core income sleeve. It sits alongside real estate credit, institutional strategies and a Treasuries-and-cash sleeve that provides liquidity, so that the portfolio's income does not rest on private credit alone. For the current positioning, see What's Inside the CDB Portfolio.
What this means for investors
Private credit has become one of the most talked-about income asset classes for good reasons: meaningful yield potential, often at floating rates, with a growing opportunity set. But the same features that make it attractive (private negotiation, illiquidity, direct lending) are also its risks. For an investor, the takeaway is not 'own it' or 'avoid it' but 'understand it': know where the income comes from, where you sit in the capital structure, how long your capital is committed, and how good the manager's underwriting is. Private credit rewards diligence and punishes complacency, which is why it belongs in a diversified portfolio rather than as a single concentrated bet.
Risks and limitations
Private credit is illiquid and carries credit, default, valuation, leverage and concentration risk. It is not safer than stocks or bonds. Market-size figures are third-party estimates that vary by source and date. Past growth does not indicate future returns.
