Private credit’s origination divide

The financial advisor take on “The Lead Left” newsletter series, authored by Randy Schwimmer, Vice Chairman and Chief Investment Strategist at Churchill Asset Management, is dedicated to help financial professionals stay informed about developments, and movements in private capital investing.

Bottom-line for advisors upfront

1. Deal sourcing, not market headlines, determines the quality of a private credit portfolio. How a manager originates and selects loans is generally the most consequential factor in long-term outcomes. 
2. Liquidity expectations matter in client conversations about private credit. The underwrite-to-hold model means these are not liquid instruments, and it is critical clients understand that limited redemption capacity is a structural feature, not a defect. 
3. Investor education about private credit's internal diversity is now the most significant challenge in the asset class, and financial professionals can help close that gap in client conversations about appropriate allocation, structure, and risk. 

In private credit, the character of your deal sourcing determines the destiny of your portfolio. How new transactions come in the door, and how you choose the best ones to close, drive your performance. Nothing else matters.

As we've learned in this series, private credit grew from the core middle market (CMM) and set the principles that became popular with issuers and investors alike: loans to small-to-medium-sized enterprises (SMEs) in diverse, defensive sectors backed by private equity sponsors with conservative terms and structures.

Select lenders stuck to this strategy even as enormous retail inflows reshaped the large end of the market. Terms there mimic bank loans and bonds — large exposures in momentum-driven sectors, high leverage, low spreads, and, critically, public style liquidity — elements contributing to private credit's current difficulties.

One friend, a veteran CLO manager, put it plainly: "You wanted to be a mature asset class? Congratulations, you're a mature asset class!" Fast growth brings scrutiny. Structures, narratives, and promises that worked in benign conditions are tested under macro pressures.

As one private credit manager has observed: "The distinction that matters is not whether a private credit portfolio has been touched by this transition, but how it was constructed in the first place." That framing applies as much to the liquidity question as it does to AI exposure. If you argue that private credit liquidity is converging with publics, investors are conditioned accordingly. Confronting the reality of 5% redemption limits had predictable results.

Bank loans and bonds are traded on secondary markets. This allows CLO managers to position portfolios to minimize risk. Large private loans don't trade, so managers, like those in the CMM, need to get it right going in. Even so, portfolio quality is governed by deal terms, which in large caps are less investor-friendly across the board than with CMM loans. That's because if they aren't borrower-friendly enough, banks can compete!

If smaller loans are less risky, why are liquid loan spreads historically tighter? The answer is that active credit traders, like public equity traders, value liquidity over almost everything. They accept lower yields and weaker structures knowing they can exit quickly if needed. If your goal is to own, not trade, CMM assets provide stronger returns and protection.

Like "Europe," "private credit" is a label for a collection of distinct entities with their own identities, legal jurisdictions, and value propositions. Investors must understand how valuations, structures, fund liquidity differ for each "nation" within the private credit "continent."

As private credit has moved from a niche to broadly held asset, investor education needs to catch up. Meeting that test is the biggest headwind in capital markets today.