When it comes to private credit, 'some caution is reasonable,' advisor says. What to know

CNBC reports that headlines about trouble in the private credit market have prompted investor questions, but financial advisors say the weakness is concentrated in pockets rather than signaling a broad-based meltdown among private credit funds. Crystal Cox, a certified financial planner and senior vice president at Wealthspire Advisors in Madison, Wisconsin, said that while some caution is reasonable, the view that private credit is on the verge of widespread trouble is overstated. She characterized the current pressure as reflecting a shift "from a young, high-return market to a more competitive, mature one where manager selection and underwriting discipline matter a lot more."

Private credit refers to loans made directly to companies by investment firms that raise capital from investors and pool it into funds. Per the article, the market has grown to an estimated $1.7 trillion, up from about $500 billion a decade ago, according to 2024 Federal Reserve research. Most private credit funds are restricted to institutional investors and wealthy individuals, with minimums of $1 million and up and lockups of seven to 10 years. About 80% of private credit fund investors are institutional as of the end of 2024, according to J.P. Morgan Private Bank. Richard Grimm, managing director and head of global credit at Cambridge Associates, said the sector is diverse, adding that "there are real pockets of concern, portfolios of concern, but the vast majority are highly cash generative."

The recent redemption requests are concentrated in semi-liquid funds, including interval funds and non-traded BDCs, which allow quarterly withdrawals and typically cap redemptions at about 5% of net assets per quarter. Cox said most of the time these funds can meet redemption requests, and if they receive too many they can cap them. J.P. Morgan Private Bank research indicates that the extra yield private credit offers over comparable public debt has been cut in half since 2022, and attributes part of the redemption rise to investors taking profits after nearly three years of outperformance.

Morgan Stanley research expects default rates in direct lending to rise to 8% from the current 5.6%, driven by AI disruption with concentration in software and AI-adjacent sectors. Software exposure among direct-lending private credit funds is estimated at 26%. Cox said the AI trade is "disrupting everything... specifically software," making those exposures riskier. CFP Scott Bishop, partner and managing director at Presidio Wealth Partners in Houston, said the situation is "less a private credit crisis and more a manager-selection and structure test" amid a broader technology transition. Cox advised that private credit exposure for most individual investors be kept to no more than about 5% of the portfolio.