BIP Capital published a Complete Guide to Private Credit for RIAs for advisors who want full coverage of the asset class. This chapter has a narrower purpose: how private credit and private equity work together to strengthen a portfolio.
What is direct lending?
Direct lending means making loans directly to private companies, typically middle-market businesses below investment grade, without a bank syndication process. The loans are usually floating-rate and frequently first-lien and senior-secured. Lenders negotiate terms bilaterally, which supports covenants, information rights, and pricing that public bond investors rarely obtain.
The asset class has scaled from a post-2008 niche into a major credit market. Preqin data shows private credit growing from roughly $2 trillion in 2020 to roughly $3 trillion, with forward projections toward $5 trillion by the end of the decade.21 Direct lending represents the largest strategy within that market.21
Where it sits in the capital structure
Position in the capital structure is the first risk question in credit. Senior-secured, first-lien lenders are repaid before junior lenders, mezzanine holders, and equity owners, and their claims are backed by collateral. That seniority drives the downside story: in a default, recovery prospects are strongest at the top of the structure. Junior and mezzanine capital earn higher yields precisely because they absorb losses earlier. Advisors evaluating any credit fund should be able to answer, in one sentence, where in the structure the fund lends.
How credit and equity sleeves work together
Equity and credit earn returns from different behaviors. Private equity compounds value over years and realizes it in exits; its return path is lumpy, and its dispersion is wide. Private credit collects contractual interest quarter by quarter; its return path is steadier, and its ceiling is lower. Together, the credit sleeve generates current cash flow that supports client income needs and can fund capital calls or rebalancing, while the equity sleeve pursues long-horizon appreciation. BDC structures reinforce the income role: to maintain RIC pass-through treatment, a BDC must distribute at least 90% of taxable income to shareholders.13
Risks specific to credit
Private credit's growth demands discipline, not comfort, and advisors should explicitly evaluate four risks.
- Spread compression. Capital flowing into the asset class competes down lending spreads, thinning the premium over liquid credit.
- Defaults and non-accruals. Credit returns are earned until they are not. Rising non-accrual rates in a portfolio are the primary warning lights.
- Payment-in-kind (PIK) income. Interest paid in additional debt rather than cash can be a legitimate tool, and it can also signal borrower stress. A rising share of PIK income deserves questions.
- Valuation smoothing. Appraisal-based marks smooth reported volatility in credit just as in equity. The critique in Chapter 11 applies here fully.