Private Credit: The Five Ways Investors Actually Lose Money

It’s easy to see why private credit has grown exponentially in recent years. Investors have been forced to think differently about their portfolios to generate growth, income and maintain capital protection. The alternatives category as a whole has surged in popularity, with private credit accompanying the rise.

Private credit is a broad space of investing. It covers any non-bank lending that is not publicly traded or issued publicly and can include loans to businesses, for buying or developing property, along with lending backed by assets (pools of investments secured by mortgages, car loans and credit card payments) or investing in debt instruments, like bonds or debentures.

Once a domain restricted to institutional and wholesale investors, the sector has become increasingly accessible to retail investors. You can even find listed private credit investments on the ASX, such as the Metrics Income Opportunities Trust (ASX: MOT) or the KKR Credit Income Fund (ASX: KKC).

In fact, the sector achieved a compounding annual growth rate of 23% in funds under management between 2015 and 2023. The growth in private credit has also been supported by borrower interest, for example, APRA regulations that tightened capital requirements for the banks from 2021 and opened the door for alternative lenders to fill the gap, particularly in the small and medium enterprise space.

There’s plenty to appeal to investors about the private credit space, especially as it grows more accessible to retail investors. It can offer higher yields compared to the publicly listed fixed income space, and diversification, as it tends to have a lower correlation to traditional fixed income markets.

At the same time, there have been growing concerns over the risks involved and whether the space needs to be more tightly regulated, particularly in the wake of two large US collapses of First Brands and Tricolor in 2025, and last month’s announcement of frozen redemptions for Blue Owl’s unlisted private credit fund.

Private markets generally can be less transparent with lower reporting requirements compared to public markets. Investors may not fully understand the risks they are taking on in the private space. ASIC even released a paper last year to explore private credit in Australia and the risks involved, flagging factors like fees, valuations, liquidity, reporting and concentration, amongst other factors.

In this article, I’ll consider five key ways investors lose money in private credit and ways to manage this.

Risk 1: Borrower Risk

Banks are subject to strict standards for evaluating the credit-worthiness of a borrower – that is, the ability of a borrower to repay their loans. Think about when you apply for a mortgage and the stack of documentation you need to provide, extending from bank statements to employment records.

While non-banks are also required to adhere to responsible lending requirements in Australia, there can be variation in how they apply this. Investors should also bear in mind that private credit investments offered by fund managers based in other regions might not follow Australian standards.

If borrowers can’t repay their loans and default, then investors will face losses of the principal from the loan.

A recent example of this is the collapse of US-based Auto loan company Tricolor which focused on subprime and often undocumented borrowers who were less likely to be able to repay their debts (and because they were undocumented, faced risks of deportation where it was unlikely that Tricolor would be able to recover their debts).

How to avoid this?

When selecting a private credit fund manager, research their process in evaluating loans, what quality of borrowers they target and see if the loans they hold in their books are independently rated by agencies. Loan books that have been independently assessed to be investment grade or above are likely to have better quality borrowers – don’t rely on a fund manager’s ‘self-assessment’ of ratings.

Risk 2: Loan structures

Beyond the quality of the borrowers, the structure of the private credit loans held in the fund can influence the level of risk you are taking on as an investor and your chances of loss.

There are a range of strategies involved in private credit and each hold different levels of risk and can sit in different parts of the capital stack (aka the hierarchy of funding which dictates the order of repayments from top priority and most secure, to least).

These include:

• senior direct lending/senior secured loans
• junior debt
• mezzanine debt
• distressed debt
• speciality finance.

Senior direct loans are often considered the lowest risk and most secure because they are backed by assets that have to be paid first before any other debts if a borrower goes into default, while distressed debt is often viewed as the riskiest because it involves loans to bankrupt or struggling firms.

How to avoid this?

Some private credit fund managers will offer funds diversified across different types of structures, while others will have a speciality. Investors needing a lower level of risk for their portfolio may be better looking for fund managers who primarily use senior secured loans where there is a better likelihood of receiving back the principal loaned in the event of a default.

Otherwise, looking for adequate diversification to offset risks from lower quality debts and across industries can help manage the risk of loss from the underlying structures.

For those looking at private credit involving greater risks and specialisation, such as distressed debt, take the time to research the expertise of the fund manager. Consider how they have performed over a range of cycles and what buffer of cash or insurance they hold. Look at the success rate they’ve had in identifying suitable distressed debt opportunities that can be turned around and the extent of involvement the fund manager takes in assisting the business in that turnaround – some private credit managers will join the board to direct strategic change for example.

Larger, more established fund managers may be better equipped to manage and offset losses, have broader access to specialist teams or have better ability to structure loans for greater protection. For example, in distressed debt, some fund managers may structure the loan to take control of borrower assets to sell in the event of default and recover some of the capital.

Risk 3: Transparency

Private market investments and reports are notoriously opaque. This can be for a range of reasons, not all bad. A fund manager may not be completely transparent in its reporting due to the desire to maintain its intellectual property, or because it is required to while in the process of setting up a loan for legal reasons. Alternatively, some funds may simply not be required to based on the reporting standards of the country they operate in.

Australian private credit funds are required to adhere to APRA and ASIC standards as part of holding an AFSL licence that allows them to offer investment funds – but bear in mind these might not match standards in other countries.

If you don’t know what you have invested into, it’s difficult to accurately assess the risks involved and what that might mean for your broader portfolio (and whether you may need to offset this risk). It can also mean you are invested in something unsuitable.

Unfortunately, lack of transparency can also hide poor corporate practices, such as poor methods of valuation or conflicts of interest in selecting borrowers for loans.

Such was one of the factors in the collapse of First Brands last year where it used off-balance sheet financing (meaning its funding wasn’t transparent to the market or ratings agencies) to fund operations and loans and was taking on greater risks and leverage than it was able to sustain.

Another factor when it comes to transparency is fee structures. While you may be aware of the fees you are paying to the fund manager for your investment in the fund, are you also aware of the full fee structure for the fund?

Consider that borrowers may be paying certain loan fees and consider any income from interest payments on the loan (not just set repayments of the principal loaned). When these are not disclosed as part of the total fee structure, it could mean you are effectively paying more than you realise – that’s a loss to your returns.

How to avoid this?

Take the time to read through the full reporting disclosures offered by your selected fund manager and take note of any information, such as fee structure or loan compositions, that might be missing.

The more transparent a report is, the better it is for you as an investor to offer understanding of what you have invested in and the level of risk it entails.

Often larger, global established firms are better equipped to offer transparent and comprehensive reporting, compared to smaller boutiques. While this doesn’t mean you shouldn’t invest in boutiques, you should bear in mind that they might hold greater risks with less buffer compared to larger firms.

Keep an eye on ASIC reports too, they can be the first warning of potential concerns about a firm’s management.

Risk 4: Concentration risk

Australia as a nation is heavily exposed to real estate risks, and it is unsurprising that private credit is heavily concentrated there too.

In the ASIC report on Private Credit, it estimated that nearly half of Australia’s $200bn private credit market was real estate focused finance. Bear in mind that there have been significant losses in real estate construction and development in recent years, from collapses in larger builders like Probuild, ABG Group, EQ Constructions or Porter Davis Homes Group.

It also leaves private credit more vulnerable to economic shocks where construction and development are usually hard-hit.

While real estate concentration is a concern for Australian private credit firms, for the US, there is a concentration in software companies which accounts for around 40% of all private equity-backed loans outstanding. The recent halt of withdrawals from Blue Owl’s private credit fund has highlighted concerns over vulnerability. Software companies have also been hard hit in equity markets off the back of concerns that AI will make them redundant.

Being vulnerable to significant parts of the public market can mean greater risk of losses in a downturn – it also negates the diversification benefit that investors may have hoped to use private credit for.

How to avoid this?

This really comes back to knowing what you are investing in and what risks it brings. Depending on your strategy, you may actually want the exposure to real estate private credit for instance, but then manage the risk in other parts of your portfolio.

Alternatively, you may seek out private credit funds with greater diversification across sectors and loans to avoid a heavy concentration to real estate. Bear in mind that there are many Australian private credit fund managers who specialise in real estate financing so be aware if that is a specialisation and you want it in your portfolio before you invest.

Risk 5: Liquidity risk

Private markets can also mean investments that are less liquid, where funds can be held for years in the development of an asset or as a loan is repaid. This is why it was traditionally the realm of institutional and wholesale investors.

Funds developed for retail investors might use a cash buffer to allow for liquidity or an alternative option. Check how they offer liquidity and what terms might be required for withdrawal so you aren’t surprised if you did need to suddenly withdraw your funds.

If you consider the collapse of First Brands, for instance, it was using new investment funds to pay off older investors – effectively a Ponzi scheme. This is illegal but ensuring there is a transparent document about how liquidity is managed can help you manage risks around this too.

Some funds will have restrictions on withdrawals to avoid liquidity problems because of the nature of the investment strategy and the loans within it. In this instance, should you need to access your funds, you may need to sell from other parts of your portfolio incurring a loss instead. Many funds offer a ‘liquidity premium’ – that is a higher yield to compensate for less liquidity.

Blue Owl’s redemption freeze is an example of a liquidity challenge. It simply didn’t have the ability to trade in its loans to match the required investor withdrawals in the face of the investor concerns over AI and software companies as quickly as needed (the fund is concentrated towards software) – though the market is still waiting to assess the true values of its loans and whether there is a deeper problem or not.

How to avoid this?

When investing in private credit, you’ll need to take the time to look at the fund structure and how it manages liquidity. You may find that you are unable to access or redeem the bulk of your investment, depending on the structure. That may be something you choose to accept and offset in other parts of your portfolio – or alternatively, you may need to reconsider whether private credit is right for your portfolio.

It is also valuable to consider whether the level of liquidity the fund claims actually matches with the underlying structure of loans – it’s one thing to say that you can redeem at any point, another thing to offer sufficient buffer in the structure for redemptions.

Certain types of loans may be easier to sell for liquidity compared to others, for example, asset-backed securities can often be easier for a private lender to sell for liquidity and typically have a market where these can be sold compared to loans for future developments or distressed securities where the lender is effectively locked in for the long-term.

Private Credit and Managing Your Risks

Chances are you already have some exposure to private credit through your superannuation fund – it’s a growing space and there’s much to appeal to investors. The potential of higher yield compared to public fixed interest markets comes with a higher level of risks that investors must consider and plan to manage in their portfolios.

Some basic principles of risk management include using established larger managers with a track-record of managing across multiple market cycles, and taking the time to understand the finer details of what you are investing in and the level of risk that might come with so you can plan for what that might entail for your broader portfolio and how it performs in market downturns.

All investing comes with risks and taking the time to understand your investments with the help of an expert can make a difference in your portfolio. It can also help you decide whether or not a particular private credit investment is the right choice for you.

Funds mentioned

Disclaimer: This article is prepared by Sara Allen. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.