Private credit is lending done by investment funds instead of banks. The fund raises capital from investors, negotiates loans directly with borrowers — most often middle-market companies too large for small-business banking and too small to issue public bonds — and earns the interest, fees, and protections it negotiated. Nothing about the loan is exotic; what changed is who makes it, how it’s held, and how investors participate.
This guide is the hub for the private credit cluster: what the asset class is, the strategies inside it, how the loans are built, how investors get access, and where the risks genuinely live.
Why funds became lenders
Bank retrenchment from leveraged and middle-market corporate lending — accelerated by post-2008 capital regulation — left a financing gap, and funds organized to fill it. The Federal Reserve’s staff overview of the asset class (“Private Credit: Characteristics and Risks,” February 2024) describes the result: a lending channel that operates outside the banking system, funded by committed investor capital rather than deposits.
That funding difference is the structural heart of the asset class. A bank funds long loans with short deposits, which is why banks face runs. A closed-end credit fund matches long loans against capital locked for years, which is why the model can hold illiquid loans to maturity. The trade lands on the investor: the illiquidity leaves the system’s balance sheet and arrives in the investor’s portfolio.
The strategy map
“Private credit” is an umbrella. The strategies under it differ mainly by where they sit in the borrower’s capital stack and what kind of borrower they face:
- Direct lending — senior, usually first-lien loans to middle-market companies; the largest strategy and the one most people mean by “private credit.”
- Mezzanine debt — junior capital between senior debt and equity, priced for its position.
- Unitranche — a single blended facility replacing separate senior and junior layers.
- Distressed and special situations — buying or originating credit where the borrower is troubled and the return comes from recovery or restructuring.
- Specialty and asset-based finance — lending against specific collateral pools (receivables, equipment, royalties, real estate debt) rather than corporate cash flow.
The cluster articles cover each; the essential point at the hub level is that these strategies share a wrapper, not a risk profile. Senior secured lending and mezzanine sit at opposite ends of the loss-given-default spectrum while both carrying the private credit label.
Anatomy of a private credit loan
A few structural features recur across strategies and explain the asset class’s behavior:
Floating rates. Most private credit loans pay a spread over a short-term reference rate, resetting periodically — the floating-rate convention. Rising rates raise the income the loans generate; they also raise borrowers’ interest burden, which is how rate risk converts into credit risk.
Negotiated protections. Because each loan is a private negotiation between a small lender group and one borrower, terms are bespoke: financial covenants, collateral, reporting rights, and amendment mechanics. The strength of these protections varies with competitive conditions — in hot markets, terms loosen; the cluster’s covenant article covers the “covenant-lite” phenomenon.
Hold-to-maturity economics. The lender typically expects to hold the loan to repayment. Returns come from contractual interest, original-issue discount, and fees — not trading gains. Some loans pay part of their interest as payment-in-kind, compounding the claim instead of paying cash; PIK preserves borrower liquidity and quietly raises risk, so its growing share of a portfolio’s income is a signal worth watching in any fund’s reporting.
Model-based valuation. Unlisted loans don’t have closing prices. Funds carry them at fair value estimated through models and, often, third-party valuation agents. Reported values are smoother than traded markets — which is partly genuine (loans held to maturity are less volatile than traded prices) and partly an artifact of measurement. An honest investor treats reported NAV stability as a feature of the accounting as much as of the assets.
How investors access private credit
The same loans reach investors through very different wrappers, and the wrapper sets the experience:
- Private funds — closed-end drawdown vehicles for institutions and eligible individuals; capital locked for years, called as deployed.
- Business development companies — regulated credit vehicles offered in listed, non-traded, and perpetual formats.
- Interval funds and tender offer funds — registered funds offering periodic, capped liquidity at NAV.
The full comparison — including who can buy what, and what each structure does with the underlying illiquidity — is in how to invest in private credit. The one-sentence version: the illiquidity of the loans never disappears; each wrapper just decides whether it surfaces as lockups, redemption caps, or share-price volatility.
Where the risks actually sit
Credit risk, concentrated in one cycle. Much of today’s private credit book was originated in benign conditions and hasn’t been through a prolonged default cycle at current scale. The Fed’s staff note is appropriately careful on this point, and so is this guide: how recoveries perform across a broad downturn is a genuinely open question, not a settled statistic. Any fund marketing that cites precise historical default and recovery figures should be read with attention to whose data, which period, and which strategy.
Leverage on leverage. Funds often borrow against their loan portfolios to enhance returns. Investor outcomes then depend on the borrower’s balance sheet and the fund’s.
Liquidity mismatch at the wrapper level. Vehicles offering periodic liquidity against illiquid loans work well until redemption demand exceeds the design. Caps and gates are disclosed features, not malfunctions — but investors surprised by them experience them as malfunctions.
Valuation lag. Marks that move slowly can understate stress in real time. The discipline is to read non-accrual disclosures, PIK trends, and amendment activity — the operational tells — rather than NAV alone.
Going deeper
- Direct lending — the core strategy
- First lien vs. second lien — priority, and why it dominates outcomes
- Unitranche — the blended facility
- Mezzanine debt — the junior layer
- How to invest in private credit — wrappers, access, and eligibility
For definitions, the glossary covers the vocabulary; for firms active in the space, see the SQX Alts directory.
This guide is educational and general; it is not investment advice.
Frequently Asked Questions
What is private credit in simple terms?
Private credit is lending done by investment funds rather than banks. A fund raises capital from investors, negotiates loans directly with borrowers—most often mid-sized companies—and passes the interest through to its investors. The loans are privately negotiated and not publicly traded, which is what makes the credit ‘private.’
How is private credit different from bonds?
Bonds are publicly issued, usually rated, and traded daily. Private credit loans are privately negotiated, mostly unrated, and typically held by the lender to maturity, with floating rates far more common than fixed. Investors give up liquidity and market pricing in exchange for higher stated yields and negotiated protections.
Is private credit risky?
It carries real risks: borrower default, illiquidity, leverage inside funds, and valuations based on models rather than market prices. Seniority matters enormously—first-lien senior secured lending and mezzanine debt are very different risk propositions that both live under the private credit label.
How do individual investors access private credit?
Mainly through registered vehicles—business development companies and interval funds—or, for eligible investors, private funds. Each wrapper carries different liquidity, fee, and eligibility terms, and the wrapper often matters as much as the strategy inside it.
Sources
- Federal Reserve, FEDS Notes: ‘Private Credit: Characteristics and Risks’ (February 2024)
- Investment Company Act of 1940 (registered-vehicle framework referenced for BDCs and interval funds)
