Private Credit: Why the Hype Deserves a Healthy Dose of Skepticism
Over the past few years, a flood of new funds, webinars and glossy slide decks has pushed private credit to centre stage. The sales pitch is seductive: annual yields near 10%, steady monthly distributions and almost no price swings. Yet, once you scratch below the surface that promise looks less like a free lunch and more like an expensive 5 course meal. The aim of this note is to explain (in plain language) what private credit really is, where those potential high returns come from, and why cautious investors may want to keep their forks down.
What private credit actually is
Private credit funds collect money from investors then lend it to private companies that either cannot – or will not – borrow from a bank.
The loans stay off public exchanges (so no live market price) and are valued only when the manager or a third-party appraiser signs off. In theory you are swapping traditional bonds for souped-up cousins; in practice you are advancing money to riskier borrowers and paying rich fees.
A typical schedule runs 1.5% for management plus a 15–20 percent performance cut – all baked into the borrower’s interest cost, which can slide into double-digits when prime was sitting near 6%.
Before we go further into the article, here are five questions to ask before signing a Private Credit subscription agreement:
- Who are the borrowers and why can’t they access bank credit? A higher rate is rarely a gift – it is payment for higher credit risk.
- What is the total fee drag? Add management, performance, fund-level leverage costs and any early-redemption penalties.
- How – and how often – are the loans valued? Monthly statements that barely budge are comforting (but only on paper).
- What is the gate? Many funds reserve the right to slow or suspend redemptions during stress – exactly when liquidity matters most.
- Could a mix of public high-yield bonds and small-cap value shares deliver a similar return profile with daily liquidity at one-tenth the fee? Independent research suggests the answer is often yes.
Why assets are pouring in
Two forces have driven the boom. First, investors were starved for yield during the long post-2008 period of near-zero rates (once rates did rise floating-rate loans offered welcome protection). Second, tougher banking rules left many small and mid-sized firms hunting for non-bank capital. When eager borrowers meet yield-hungry investors money moves fast – global private-credit assets have already topped $1.6 trillion USD.
The pitch versus the economic reality
Marketing decks love to highlight stable distributions and low volatility – yet those smooth return streams are mostly an accounting illusion. Due to loans being re-valued quarterly (or even less) price changes emerge slowly. A growing body of academic work
(most notably “Direct Lending Returns” in the Financial Analysts Journal linked here: https://rpc.cfainstitute.org/research/financial-analysts-journal/2023/direct-lending-returns)
shows that close equivalent public versions of private credit (called business-development companies) look impressive when judged at manager-reported net-asset value, but their excess return vanishes as soon as the same loans are marked to live trading prices.
High yields also look less generous once fees are stripped out. All-in costs of 3-4% per year are common, so a good chunk of the yield you see on the pitch deck goes straight to the manager (not to you).
“Straight from the data”
1) “A typical private debt fund produces an insignificant abnormal return to its investors… rates at which private debt funds lend appear to be high enough to offset the funds’ fees and risks, but not high enough to exceed both their fees and investors’ risk-adjusted rates of return.” (Erel, Flanagan & Weisbach (2024), NBER Working Paper 32278)
2) “Private credit funds yield high total returns compared with other debt instruments. For example, the rate spread… averages about 630 basis points (bp) on loans by private credit funds, exceeding that on leveraged loans by about 300 bp. However, once risk and fees are considered, private credit does not provide abnormal returns.” (BIS Quarterly Review (2025), Summarizing Erel et al. (2024).)
On the other hand, true investing looks kind of… boring. But in a good way.
Risk that hides in the shadows
Most companies that need private lending have to accept less favourable conditions, particularly the fact that the loans are floating rate, so rising rates help the lender (payments reset higher) while simultaneously squeezing borrowers who were already too risky for banks. Defaults may stay quiet for a while then spike. Worse, the asset class has not faced a full credit cycle at its current size – nobody really knows how severe the next downturn could be.
My personal opinion is that the opaqueness and ‘smoke and mirrors’ of these asset classes are the cause of financial catastrophes – think 2008. It is all “OK” until it isn’t.
Return smoothing brings its own danger. Overly simplified, this means that if the fund returns 30% in one year and -15% in another year, they may report it as an ~7.5% gain in year 1 and in year 2 because they are not forced to show the daily price of the fund, e.g. they don’t need to mark to market regularly. A portfolio that reports almost no volatility can tempt retirees to treat it like a bond ladder, yet the economic risk is closer to a blend of small-cap value funds and below-investment-grade bonds – two public assets that can be bought (rebalanceable daily) at a fraction of the cost.
Where (if anywhere) private credit may fit
Large institutions with deep credit teams may find niches where the economics work – especially when they negotiate fee breaks and can absorb multi-year lock-ups. For most individual investors (particularly those seeking low-risk income) the trade-off of illiquidity and opaque pricing for a fee-trimmed equity-like return is hard to justify, and the reality is that even if you had access to the same funds as these institutions (which would require you to have millions of dollars available to allocate to the fund), you then need to pick the right fund/fund manager, which as we know is nearly impossible to do consistently over any meaningful period of time in the public markets.
Key takeaways
Private credit’s rich yield springs from three sources – weaker borrowers, floating-rate structures and high embedded fees – rather than market magic. Low reported volatility reflects slow accounting (not reduced risk). Until real-time market data confirm a persistent excess return, a healthy dose of skepticism remains the best risk-management tool available. And as always, remember – there is no free lunch in investing. EVERYTHING has a trade off.
Disclosures:
Private credit funds and other investment strategies discussed may not be suitable for all investors. Investment decisions should be based on individual objectives, risk tolerance, time horizon, and financial circumstances.
Important information about mutual funds is found in the Fund Facts document. Please read this carefully before investing. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. Unit values and investment returns will fluctuate.
The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of our knowledge as of the date of publication. Rules and their interpretation may change, affecting the accuracy of the information. The information provided is general in nature and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors.
References:
- BIS Quarterly Review (2025):
Bank for International Settlements. (2025, July). The global drivers of private credit. BIS Quarterly Review. Retrieved from https://www.bis.org/publ/qtrpdf/r_qt2503b.htm - Erel, Flanagan & Weisbach (2024):
Erel, I., Flanagan, K., & Weisbach, M. S. (2024). Risk-Adjusting the Returns to Private Debt Funds (NBER Working Paper No. 32278). National Bureau of Economic Research. https://www.nber.org/papers/w32278
Stick to a plan. Stay diversified. Keep costs low. Avoid the noise.
And remember: boring investing is often the most effective.
