Private credit can offer income and diversification, but its attractiveness depends heavily on underwriting quality, structure, liquidity and the economic environment.
Understand the source of return
Higher yields are compensation for something: illiquidity, complexity, leverage, borrower quality, covenant structure or market dislocation. Investors should identify the source rather than focus on the headline yield.
Underwriting matters more than the label
Manager discipline, collateral, covenants, recovery assumptions and sector concentration can matter more than the broad category of private credit.
Illiquidity is a portfolio decision
A private credit allocation should be sized in the context of total liquid resources and future capital needs. Attractive yield does not remove the cost of locked capital.
Stress defaults and recoveries
Base-case income is only part of the analysis. A credible assessment should consider defaults, recovery timing, refinancing risk and what happens if distributions are delayed.
A short decision checklist.
- What job is this capital expected to perform?
- What are the principal sources of return and loss?
- How much liquidity could be needed under stress?
- What assumptions would invalidate the decision?
- What review rule will govern the allocation after the initial decision?