Five years ago, private credit paid investors well for accepting illiquidity and opacity. With core bond yields at multi-year highs and private credit defaults climbing, the argument for sitting in unrated, hard-to-sell mid-market loans has all but disappeared.
The pitch for private credit used to be simple. Public bonds yielded very little. Private credit paid 8% or more. You sacrificed liquidity and accepted opacity, and in return got equity-like returns from instruments higher up the capital structure.
That pitch does not hold anymore. Ten-year gilts now yield around 5%. US treasuries pay 4.6%. ‘AAA’ US corporates offer 5.2%, BBBs 5.5 and BB-rated high yield offers 6%.
You can build an attractive income-generating portfolio from the public bonds of Apple, Microsoft and other global champions – companies you have actually heard of, whose accounts are audited quarterly, whose paper you can buy or sell in seconds – and clip a yield that would have been fantasy five years ago.
Private credit, by contrast, is still being marketed at roughly the same level. Yields for large US corporate private credit borrowers hit 7.5% in April before settling back to around 7%, which is the giveaway.
In 2021, a 7% private credit yield against a 1% gilt gave you 600 basis points of compensation for the lack of liquidity and transparency. In 2026, that same 7% yield against a 5% gilt is 200 basis points.
Against BB publicly rated corporates, the premium shrinks to 100. That is not much cushion for locking your money in unrated, lightly traded, sponsor-backed loans to mid-market software companies most allocators will have never heard of.
No margin for error
The default picture is also worsening. Fitch put the US private credit default rate at 6% in April. Morgan Stanley estimates it could climb to 8%. In the worst-case scenario, UBS claims it could reach as high as 15%.
Compare that with the public market. AAA-rated corporates have defaulted in zero years since 1981. Even at the top end of the high-yield market – the double-Bs – annual defaults have not topped 1% since 2002.
S&P expects the broader US speculative-grade default rate to nudge up to 4% next March, but that number is heavily skewed by the triple-Cs and worse cohort.
So, private credit defaults are running well above the speculative-grade public market and well above anything an investment-grade investor would tolerate. The yield premium, meanwhile, has shrunk materially. There is no longer a margin of safety.
There is also the question of what these funds own. US private credit is heavily concentrated in software and adjacent sectors – making up 29% of total loan assets held by business development companies (BDCs) and interval funds.
The broadly syndicated loan market, perhaps the best proxy for secondary pricing in private credit, has software loans trading at 88 cents on the dollar. Many private credit funds still carry theirs at par. One of those numbers is wrong.
The illusion of low volatility and liquidity in private credit
Private credit has historically been sold on its potential to provide high yields with low volatility. More recently, liquidity has become part of the sales package. But what has been presented as low volatility is really just unobserved volatility.
What we have seen this year in the US BDC market has proved the point, causing much angst to investors who thought they were getting the yields of their dreams and liquidity.
Putting the house on private credit could be justified when public credit and core bond yields were negligible, as they were from 2012 to 2021. That world is long gone.
The upside in private credit is modest at best, the downside is considerable, and the exits have been shown up to be narrow in times of trouble. For investors who can still get out, there is a strong case for switching back into liquid and transparent public bond markets where you can still buy or sell, minute by minute, second by second.
Alex Ralph is a senior fund manager at Nedgroup Investments. The views expressed above should not be taken as investment advice.