“The greatest obstacle to discovery is not ignorance—it is the illusion of knowledge.”
— Daniel J. Boorstin
Last year, tariffs dominated the headlines. After an initial wobble, markets largely absorbed the news and finished the year with better-than-average returns across both stocks and credit. As that story faded, a new perceived threat emerged in parts of the financial press: private credit. Since the turn of the year, warnings about the asset class have become louder and more frequent1, yet private credit itself has continued to behave largely as expected. So, are recent sellers the smart money or have they obtained the “illusion of knowledge”?
That question is easier to answer once we clarify what private credit actually is, what investors are being paid for, and where the real trade-offs lie. The short version is simple: private credit is not magic, and it is not risk-free. But it is also not the house of cards that some recent coverage suggests. In many portfolios, it can play a useful role precisely because its risks and rewards are different from those of traditional stock and bond holdings.
| Key takeaway. Private credit is mostly a trade of liquidity for yield and diversification. In exchange for giving up daily liquidity, investors can gain higher income, smoother returns, and low correlation to traditional bonds and stocks. |
What Is Private Credit?
Private credit is simply a loan made to a private company rather than to a public one. Lending money to Ford or Apple is public credit – what most investors would call a corporate bond. Lending money to a private business such as OpenAI or Subway is private credit. The most important distinction is not that one borrower is automatically safer than the other. The key distinction is liquidity. Public bonds can usually be traded before maturity, while private loans generally cannot.
That liquidity difference matters. A public bond can often be sold in the market if the investor no longer wants to hold it. A private loan usually must be held until it matures, is refinanced, or is otherwise repaid. Private debt also tends to be shorter-dated than much public debt. Many direct loans mature in roughly five years, while public issuers can sell bonds with maturities measured in decades.
The example above is known as direct lending: a fund lends directly to a company rather than buying a widely traded bond in the market. Private credit is broader than direct lending and also includes areas such as aviation finance, asset-backed lending, and distressed debt. Within direct lending, loans can be senior or junior, which affects repayment priority if the borrower runs into trouble. Most of what we use at Omega Financial is senior direct lending, so that is the focus of the discussion that follows.
Why Own It?
We invest in private credit because it has the potential to offer higher returns than public bonds while also bringing low correlation to traditional markets. The price of those benefits is lower liquidity. That trade-off is the source of the illiquidity premium: for similar underlying credit risk, private lenders may earn yields roughly 2 to 5 percentage points higher than public bond investors.
For long-term planning, we assume private credit returns about 8.5% per year with 5% annual volatility. That implies a typical one-standard-deviation return range of 3.5% to 13.5%. For comparison, investment-grade corporate bonds might return about 4.0% with a similar 5% volatility, while high-yield bonds might return about 6.5% with 9% volatility. Just as important, private credit has historically shown much lower correlation with traditional stocks and bonds than most public credit has. That makes it a useful diversifier rather than just a higher-yielding substitute.
The StepStone chart above shows how direct lending (‘US DL’) has behaved over the past 20 years relative to other major asset classes. In 2008, direct lending was down about 6.5% – painful, but far better than public high yield bonds and far better than public equities. In 2022, when rising rates punished traditional bonds, private credit still delivered a positive return. Over the full period shown, direct lending earned returns closer to stocks than to bonds, but with much lower volatility. Past performance never guarantees future results, and these realized numbers are stronger than our long-term planning assumptions. Even so, the chart helps explain the asset’s ability to add value.
What about liquidity?
There is no free lunch. Instead of a mutual fund or ETF that can be sold any business day, most private credit vehicles now offer some form of quarterly liquidity. In older limited partnership structures, capital could be tied up for as long as 7 to 10 years. Today’s more investor-friendly versions are usually structured as interval funds or tender-offer funds.
An interval fund generally must offer to repurchase at least 5% of the fund’s net assets each quarter. A tender-offer fund typically states an intended quarterly repurchase amount, often also 5%. These structures work because the underlying loans are relatively short-dated, often with average maturities around five years, and because many portfolios hold some cash, liquid credit, or both. Very roughly, a five-year average maturity means about one-fifth of the portfolio turns over each year before considering prepayments, which suggests adequate liquidity to repurchase 20% of the portfolio per year.
Recent headlines often portray a 5% quarterly redemption cap as a flaw. In reality, it is part of what makes the strategy possible. Without a cap, managers would need to hold far more liquid assets, which would dilute the very illiquidity premium investors are seeking. The key point is that repurchase limits are a feature of the structure, not necessarily a sign of distress. If 10% of a fund requests redemption in a quarter and the fund offers 5%, then each redeeming investor typically receives 50% of the amount requested that quarter, with the rest waiting for later repurchase windows.
What about leverage?
Many direct lending funds also use modest leverage. In practice, funds we use often borrow in the neighborhood of 20% to 40% of total assets, though levels vary. Conceptually, leverage can be helpful because it allows a fund to borrow at a lower rate than the yield it earns on its loan portfolio.
To make that concrete, assume a fund is financed 75% with equity and 25% with debt. If the unlevered portfolio earns 8.0% and borrowing costs 5.0%, the return on equity is:
8.0% + (25% / 75%) x (8.0% – 5.0%) = 9.0%
That extra 1.0% comes from earning a positive spread on borrowed money. But leverage works both ways. If the underlying portfolio instead loses 4.0% in a bad year, the equity return becomes:
-4.0% + (25% / 75%) x (-4.0% – 5.0%) = -7.0%
In other words, leverage can materially help in normal environments, but it also amplifies downside when results turn negative. Over time, moderate leverage can improve long-run returns without excessively increasing risk.
What about defaults?
Another common concern is defaults. Private credit does lend to riskier borrowers than investment-grade bonds do, so default losses are part of the story. Historically, however, loss rates have been manageable relative to income earned. If gross interest income is a bit above 9.5% and long-run credit losses are about 1.0% per year, that still leaves a net return around 8.5%. Last year, Cliffwater estimated default-related losses at roughly 0.7%. Moving from 0.7% back to the 1.0% long-run average would require an increase in the current default rate of over 40%. Default rates will certainly rise to higher levels during our next recession. The important question, however, is whether they rise enough to overwhelm the income cushion. Historically, they have not.
What about all the recent redemptions?
Another issue now showing up in headlines is redemptions. Some private-credit funds have recently received more redemption requests than they could fully meet within their normal quarterly repurchase limits. That is what the chart below from the Wall Street Journal is showing. The light-colored portion labeled ‘Unmet’ represents requests beyond the amount the funds were prepared to repurchase that quarter.
In the first quarter of 2026, the chart suggests investors, on average, may have received about half of what they asked to redeem, with the remainder pushed to the next quarter. That is not ideal, but it also is not unprecedented. Similar pressure appeared during the early months of the pandemic. More important, a few quarters of heavy redemption activity do not erase the much longer history of net inflows into the asset class, shown in the next figure, which includes purchases in addition to redemptions for a more complete picture of investor activity.
That longer-term view also reveals an irony. About a year ago, some observers were warning that too much money was pouring into private credit. Excess inflows increase competition that can pressure underwriting standards, resulting in narrowing spreads (i.e., lower yields) and weakening covenants (i.e., lighter investor protections). This means lower return potential and greater risk for private credit investors, ceteris paribus. From that perspective, some investor outflows can actually improve the opportunity for the capital that remains.
A Little Bit of Magic
I will close with a little bit of (math) magic: how adding something ‘riskier’ can sometimes make a portfolio safer. Suppose investment-grade bonds are expected to return 4.0% with 5.0% annual volatility. Suppose private credit is expected to return 8.5% with the same 5.0% volatility, and that the correlation between the two is just 0.19. A 50/50 mix has an expected return of 6.25%.
Its expected volatility is (for the math lovers in the crowd):
sqrt((0.5^2 x 5^2) + (0.5^2 x 5^2) + (2 x 0.5 x 0.5 x 0.19 x 5 x 5)) = 3.86%
That is ~23% lower volatility than either asset has on its own.
| Portfolio | Expected return | Volatility | Approx. 2-sigma downside |
| Investment-grade bonds only | 4.00% | 5.00% | -6.0% |
| 50/50 bonds + private credit | 6.25% | 3.86% | -1.5% |
Using a simple two-standard-deviation approximation, investment-grade bonds alone have a 12-month return downside of around -6.0%, while the blended portfolio improves that to just -1.5%. Thus, we increased expected return while reducing overall volatility, not because private credit is ‘safer’ in every sense, but because its risks are different. That is the complementary asset effect: combining the right assets to reduce downside 75% and increase upside more than 25%.
As always, there are real uncertainties ahead. That is why our process emphasizes owning assets that behave differently during various macroeconomic events. This approach is at the core of our States of the World Wealth Management® process. And private credit is just one of the important tools we use to accomplish this. After all, I never know which asset will be best in a given year, but I do know that the assets we own are different. And different is good…
- I will not address the Iran conflict in this commentary. As I pen this article, we have entered a “fragile truce,” so stay tuned!
