What it replaces, and what it does not
Private credit is a partial substitute for high-yield bonds and broadly syndicated loans: the same borrower population, similar seniority, different liquidity, and different pricing cadence.
Private credit is not a substitute for the defensive role of Treasuries or investment-grade credit. Those holdings are intended to be sold at par in a crisis and to rise when growth disappoints. Private credit does neither. An advisor who funds a private credit allocation from a client's defensive sleeve has removed the portfolio's shock absorber and replaced it with an income stream.
Duration, rates and the honest tradeoff
Floating-rate loans carry almost no interest-rate duration, a considerable advantage in 2022. The symmetry is often left unsaid: when short-term rates fall, private credit income falls with them, whereas a fixed-rate bond's income does not.
The table's lower-right quadrant is the one worth sitting with. A falling-rate environment reduces private credit income while easing borrower stress, whereas a rising-rate environment does the opposite. Neither is simply good or bad, and both deserve explanation to a client before the allocation is made.
Correlation, read critically
Reported correlations between private credit and public markets are low, and part of that is genuine. Loans are negotiated bilaterally, income is contractual, and value does not reprice with daily sentiment.
Part of it is measurement. Federal Reserve research notes that private credit is valued "based on internal or third-party models (quarterly)" while leveraged loans are priced daily.2 Quarterly model-based valuation produces smoother reported returns than daily market pricing, regardless of the underlying economics.
A third consideration is less common among advisors. Academic research finds that private debt funds carry equity-like risk: Erel, Flanagan and Weisbach conclude that "using both equity and debt benchmarks... a typical private debt fund produces an insignificant abnormal return," and that "using only debt benchmarks also leads to positive abnormal returns as funds contain equity risks."19 In other words, benchmarking private credit purely against bonds flatters it, because some of what it earns is compensation for equity risk.
What the return evidence shows
Two independent pieces of research frame the realistic case.
Matvos, Piskorski and Seru examined 1,267 private credit funds and found mean annualized net returns to limited partners of 9.6%, with a median of 9.1% and a fifth percentile around -3.8%.20 This is a respectable distribution with a real left tail. Past performance is not indicative of future results.
Erel, Flanagan, and Weisbach's risk-adjustment finding sits alongside it: once both equity and debt benchmarks are applied, the typical fund's abnormal return is not statistically significant.19 The honest synthesis is that private credit has delivered solid absolute returns, that fees absorb a meaningful share of the risk-adjusted premium, and that manager selection, rather than asset-class exposure, determines whether an investor captures what remains.
Sizing
Three constraints should determine the size of a private credit sleeve, and none of them is a return forecast.
- The liquidity budget. Chapter 6's four-quarter gate test is the binding constraint for nearly all individual clients.
- The income requirement. For a distribution-phase client, size to the income needed, with a margin for distribution cuts.
- Concentration discipline. Diversify across managers, market segments, and vintages. A single manager allocation is a single underwriting process.
Any illustrative allocation an advisor models should be labeled an estimate, with its assumptions stated, consistent with Chapter 7.