Private Credit and Direct Lending: The Alternative Fixed Income Opportunity

For most of the post-war period, companies needing to borrow money had two main options: banks and public bond markets. Banks provided loans of various sizes; bond markets allowed larger companies to issue debt to institutional investors. The 2008 global financial crisis disrupted this equilibrium permanently. New capital requirements forced banks to hold more capital against corporate loans, making mid-market lending — to companies too small for bond markets but needing more than banks wanted to provide — less attractive for the banking sector.

Into this gap stepped a new generation of non-bank lenders: private credit funds managed by alternative asset managers. Today, private credit is a roughly $3 trillion global asset class (industry estimates for 2024–25 range from around $2.3 trillion to $3.5 trillion depending on the source and scope), with managers including Ares, Blackstone, Apollo, HPS, Blue Owl, and dozens of specialist firms providing capital to companies that might once have relied entirely on bank financing.

For investors, private credit offers something that is genuinely rare in a low-to-medium-rate environment: meaningful yield above investment-grade bonds, with senior secured collateral providing some downside protection. Understanding what you are buying — and the genuine risks involved — is essential.

The private credit universe

Private credit encompasses several distinct sub-strategies with different risk and return profiles.

Direct lending is the largest segment. Senior secured loans are made directly to mid-market companies — typically businesses with EBITDA of £20 million to £250 million — by private credit funds. These loans sit at the top of the capital structure: if the company defaults, direct lenders are first in line to be repaid from the assets. Loan terms typically include maintenance covenants that require the company to meet financial tests quarterly, providing early warning if the borrower deteriorates. Returns target SOFR/SONIA plus 4-7%, with total yields in the 2023-2024 cycle reaching 9-12%.

Mezzanine debt sits below senior secured debt in the capital structure — it is repaid only after senior lenders are satisfied. In exchange for this subordinated position, mezzanine lenders receive higher interest rates (often with payment-in-kind options) and sometimes equity warrants. Risk is higher than direct lending; return targets are correspondingly higher: 12-18% in recent market conditions.

Unitranche lending combines senior and mezzanine debt into a single loan from one lender or lending group. Simpler for borrowers (one relationship, one set of documents), with a blended interest rate between senior and mezzanine.

Distressed debt involves purchasing the debt of companies in financial difficulty — often at 50-70 cents on the dollar — with the expectation that the company will restructure and the debt holder will emerge with either a higher value loan or equity in the restructured entity. This is the highest-risk, highest-potential-return segment and requires deep credit and legal expertise.

Asset-backed lending involves loans secured against specific assets: real estate (bridge loans), aircraft, infrastructure, receivables, or intellectual property. The tangible security provides downside protection if the borrower defaults.

Specialty finance includes a growing range of niche lending activities: royalty financing, litigation finance, revenue-based financing for software companies, insurance-linked lending.

The return profile

Private credit's appeal as an asset class was transformed by the rate-hiking cycle of 2022-2023. Most private credit loans are floating rate — they pay a margin above the prevailing base rate (SOFR in the US, SONIA in the UK). When base rates were near zero, direct lending returns of 5-7% were attractive relative to investment-grade bonds yielding 2-3%. When base rates rose to 5%+, the same credit spread delivered total yields of 9-13%.

This is the floating rate feature that makes private credit distinctive: unlike fixed-rate bonds, which suffer when rates rise (because their fixed coupon becomes less attractive relative to new bonds), private credit loans benefit when rates rise — the floating rate coupon goes up automatically.

The flip side is the same: when rates fall, private credit yields compress. As central banks began cutting rates in 2024-2025, private credit yields moderated from their 2023-2024 peaks. Nevertheless, the spread over investment-grade bonds — reflecting the illiquidity premium, complexity, and credit risk — typically persists through rate cycles.

The illiquidity premium

Private credit funds are not like mutual funds or ETFs. A typical direct lending fund has a lifespan of 5-7 years: capital is committed during an investment period, loans are made, repayments are recycled, and the fund winds down. Investors cannot exit during the fund life by selling their interest at will.

This illiquidity is compensated by the "illiquidity premium" — the additional yield private credit earns versus publicly traded loans with similar credit risk. Academic research and practitioner estimates suggest this premium is approximately 1-2% per annum over the fund life. Whether this is adequate compensation depends on the investor's specific liquidity needs.

Some private credit funds offer periodic liquidity windows — quarterly redemptions with notice periods — but these typically involve gates that limit withdrawals during periods of market stress. The experience in 2022-2023, when some retail-targeted non-traded REITs and credit funds restricted redemptions, illustrated that liquidity windows can close precisely when investors want them most.

Business Development Companies: listed access to private credit

For investors who want private credit exposure without the illiquidity of a traditional fund, Business Development Companies (BDCs) offer an important alternative.

BDCs are US-regulated investment companies that lend to mid-market businesses and are listed on stock exchanges, providing daily liquidity. They are required to distribute at least 90% of their taxable income as dividends, making them income-oriented listed vehicles.

Ares Capital Corporation (ARCC) is the largest BDC by assets under management. As of 2026, it has a portfolio of around $30 billion (fair value) in loans to mid-market US companies. It is listed on NASDAQ and accessible to investors globally via any broker that provides US equity access. Its dividend yield has historically been in the 8-10% range.

Blue Owl Capital Corporation, FS KKR Capital, and Prospect Capital are other significant listed BDCs.

The liquidity of BDCs comes with a trade-off: BDC share prices fluctuate with market sentiment, sometimes trading at significant discounts to their NAV — particularly during periods of credit stress. In March 2020, BDC prices fell sharply as markets priced in a recession, even though the underlying loan portfolios had not yet experienced defaults at the same rate. Investors who sold at the bottom crystallised losses that were largely recovered by those who held.

ELTIF access for European investors

European investors are increasingly able to access private credit through the ELTIF (European Long-Term Investment Fund) structure, which was reformed in 2023 to allow retail investor access at lower minimums (previously €10,000+). Several major managers — Ares, Blackstone, Schroders Capital — have launched ELTIF-structured private credit products targeting European retail and high-net-worth investors.

ELTIF structures offer a degree of liquidity (typically quarterly windows) not available in traditional closed-ended private credit funds, though full liquidity is not guaranteed.

UK investment trusts in private credit

The UK's listed investment trust universe includes several credit-focused trusts that provide exposure to private and alternative credit:

Sequoia Economic Infrastructure Income Fund invests in senior infrastructure debt. TwentyFour Income Fund invests in asset-backed securities and loans. Fair Oaks Income provides exposure to collateralised loan obligations (CLOs) and direct lending.

These trusts are accessible to any investor via a standard stockbroker account and provide daily liquidity at a price per share, though they may trade at discounts or premiums to NAV.

Credit risk and recession sensitivity

Private credit's most significant risk is credit risk: the possibility that borrowers default and that recovery values are insufficient to return capital. Mid-market companies — the primary borrowers in direct lending — are generally more leveraged and less diversified than investment-grade public companies. They are more vulnerable in economic downturns.

Historical default rates in private credit have been modest in benign economic conditions — typically 1-3% per annum at the portfolio level. However, in severe recessions, default rates rise significantly. The 2008-2009 financial crisis saw leveraged loan default rates of 10%+ in the US. Even with senior secured positions and recovery rates of 60-70 cents on the dollar, substantial capital losses are possible in a deep recession.

The covenant protection in private credit loans — which requires borrowers to maintain certain financial ratios — is intended to provide early warning and the ability to restructure before full default. In practice, covenant waivers and amendments have become common in recent years as lenders compete for deals, raising questions about the adequacy of investor protection.

Investors in private credit should size their allocation to a level where a 15-30% loss in the private credit portion of their portfolio — possible in a severe recession — would be manageable within the overall portfolio context.

The legitimate role in a portfolio

At its best, private credit is a genuinely attractive complement to public fixed income. The floating rate structure, senior secured collateral, and illiquidity premium produce a return profile that can fill a gap in a diversified portfolio: income higher than investment-grade bonds, credit exposure to a different part of the corporate universe, and some protection against rising rates that is absent in fixed-rate bond holdings.

The recommended approach: access private credit primarily through listed vehicles (BDCs, investment trusts) for the initial allocation, adding illiquid fund exposure only once the portfolio has grown to a scale where true illiquidity can be accommodated without affecting financial flexibility. Keep the allocation within the alternatives sleeve at 5-15% of the total portfolio, and maintain a substantial portion of the portfolio in genuinely liquid assets as a counterbalance.

How Global Investments can help

Our advisers can help you assess whether private credit is appropriate for your portfolio given your income objectives, liquidity requirements, and risk tolerance. We can guide you through the universe of accessible vehicles — from listed BDCs and UK investment trusts through to ELTIF structures and private credit funds for qualifying investors — and help you size any allocation appropriately within a diversified portfolio. Contact us for a consultation.