Private credit remains popular among LPs, but the asset class faces a testing time ahead as tariffs and geopolitical uncertainty weigh on M&A and business growth plans
Now firmly in the mainstream of LP portfolios and business financing options, private credit looks set for further growth in the coming years. With nearly half (49%) of LPs saying they planned to increase their allocations to the asset class in 2025 and just 9% expecting a decrease, according to a Preqin survey, private credit is clearly finding favour among investors.
But how is the asset class faring today as the spectre of continued inflationary pressures and tariffs seem likely to dent business and consumer confidence? And how are existing portfolios holding up at a time of high uncertainty? A range of seasoned LPs and GPs offer their perspectives on an asset class maturing in volatile times.
While private credit has grown up in a relatively benign environment, with low interest rates and inflation helping fuel economic and business expansion, some say it has never been plain sailing. "Since we started out, there has been a series of macro challenges to take account of in our deployment decisions," says David Wilmot, Partner at Apera Asset Management. "The vote for Brexit meant we sometimes had to justify investing in UK businesses to LPs, then came Covid, followed by the war in Ukraine and inflation. We’re not underestimating the impact of today’s uncertainty, but it does create an interesting investment environment as liquidity has not dried up and there continue to be good deals for us to do on good terms. We have to look at how impacted businesses may be by the current macros, but that fundamental approach should be non-negotiable in any environment."
Volatile environments are usually a source of opportunity, says Mark Brenke, Head of Private Credit at Ardian. And private credit benefits from long-term capital – that allows us to look through short-term volatility and use uncertainty to negotiate better outcomes. You can get reduced risk positions for the same returns.
It is very difficult to get buyers and sellers to come together on price when there is so much uncertainty on the effect of tariffs, adds Michael Craig, Head of European Senior Loans at Invesco. It’s not insurmountable, but it’s far from helpful.
"This asset class demands a stable decision-making environment," says John Bohill, Partner at StepStone Group. “Yet right now, we see doubt among business leaders, especially concerning the effect of tariffs. The lack of certainty in the US is causing sponsors to delay exits further and we may see M&A challenged in Europe over the medium term.”
And there is little sign this will change for some time to come, say some. "M&A will be subdued in the US for the next six months," says John Brignola, Senior Managing Partner at CIFC. "Bankers claim to be busy on their sale books, but we’re not seeing that – pipelines are less full than over the past two years and the dynamics are not changing. However, when there is greater clarity, this will change."
"We’re spending a lot of time on opex-intensive businesses as there is more flexibility here than in capex-heavy companies, especially in these volatile times," says Andreas Klein, Head of Private Debt at Pictet Asset Management. "It’s also a pivotal moment since technology will offset inflationary factors and help preserve margins. We’re very focused on defensible cash flows in businesses that provide mission-critical services or product to their customers."Nik Singhal, Group Head of Direct Lending at ORIX, agrees. "The US direct lending market is big and mature," he says. “By focusing on businesses with strong free cash flow generation, it has consistently delivered for the past two decades. If a manager has to change strategy in response to credit cycles, by that time it’s usually too late anyway.”
We need to be delivering stable, risk-adjusted returns to our investor regardless of market conditions, says Brenke. That doesn’t mean adapting our business model because times are volatile – credit performance is fundamentally down to sourcing and underwriting strength.
US private credit default rates for the trailing 12 months to February stood at 5.7%, according to Fitch Ratings, a rise from the 5% recorded in January, but still relatively low, given the environment. Proskauer, meanwhile, reported a rate of 2.67% in its Q4 2024 Private Credit Default Index of US senior and unitranche loans, a level broadly similar with Q2 2024.
"Our transactions continue to be characterised by strong downside structural protections, but looking more widely at the data on market default levels it feels a little false at the moment," says Wilmot. "The level of defaults does not seem to reflect the likely effect of high leverage in larger transactions and the high cost of debt capital environment. We’ve still got some way to go before we see what happens with market defaults and the impact upon lenders. One indicator is that we hear more about PIKs in larger deal structures – which has typically been a sign that leverage is too high – and I suspect that there may need to be more PIK issuance and maturity extensions to make the numbers work on some of those transactions."
The range of return outcomes from private credit managers within the same strategy has historically been far narrower than in most other private markets asset classes, but the coming period may see that change. "With the rise in interest rates, I would have expected to see more stress as lending costs doubled," says Emma Bewley, Partner and Head of Credit at Partners Capital. "The risk of rates staying quite a bit higher for longer suggests there is potential for more issues in private credit portfolios. Combined with the fact that huge amounts of capital flowed to certain parts of the market, leading to competitive pressures which in turn weakened credit protections, we expect to see much greater dispersion of returns in the asset class."
“Private credit is entering adolescence,” adds the chief investment officer of a private credit firm. “These could be awkward and uncertain years. We’ve left behind the beta trade environment of zero base rates, the recession-free economic backdrop and enterprise value multiples climbing to the moon. We expect there will be much more dispersion between managers who know how to fix their mistakes and manage underperforming credits and those who don’t. We will see mishaps, mistakes and disappointed LPs. Investors should look for managers who have experience throughout various cycles and understand clearly how to minimise principal loss.”
With 18% of LPs in a recent Preqin investor survey suggesting they are looking at reducing their allocations to private equity, many believe that private credit could be a beneficiary – but only when exits begin to flow through meaningfully. “The biggest impediment to private credit is the low level of distributions from private equity,” says Bohill." There is a white space for private credit to catch up with private equity, but we need to see capital returned first so it can flow through to private credit."
With the rise in interest rates, I would have expected to see more stress as lending costs doubled. […] The risk of rates staying quite a bit higher for longer suggests there is potential for more issues in private credit portfolios
