The market for private-credit investing is huge and growing. According to one estimate, some $1.5 trillion is invested in these nontraded, alternative assets, up from $440 billion a decade ago. A recent Goldman Sachs survey finds that 64% of family offices have exposure to the asset class, and another 30% plan to allocate more money to it in the next year.

The reasons are pretty straightforward. After the Global Financial Crisis, regulators constrained speculative lending by banks. In the last year, higher interest rates made borrowing more costly. The regional banking crisis further slowed traditional lending. Private credit is filling the void.

“Private credit is experiencing tailwinds related to rising rates and reduced competition from the banks,” said Nayef Perry, managing director and global co-head of direct credit at Hamilton Lane, the Conshohocken, Pa.-based investment manager and private markets expert. Private-credit investors, he added, can now achieve yields of 10% or greater.

But for how long?

Making The Case
“Expectations of 12%-plus returns don’t constitute a ‘big promise,’” said Stephen Nesbitt, CEO of Cliffwater, a New York City-based alternative-investments advisory firm, by email. “The return comes in the form of cash yield, which investors can pretty much bank.”

For many, that’s irresistible. “The opportunity for enhanced yield and lower correlations to public equity and fixed income is very attractive,” said Robert Behan, executive vice president and chief distribution officer at Calamos Investments in Chicago, which recently partnered with Aksia to launch a private credit fund.

Christopher Alan Zook, chairman and chief investment officer of CAZ Investments in Houston, said that roughly $200 billion of debt issued by traditional banks will mature in the next two years, and most of that will need to be refinanced.

“Private-credit providers will be well-positioned to capitalize on the opportunity,” he said, making this a “lender’s market” with “more lender-favorable terms."

Or Not
But some people have doubts. “In a world in which 5% T-bills are a reality, the added risk and illiquidity of private credits make less sense,” said Charles Lewis Sizemore of Sizemore Capital Management in Dallas.

Others point out that many of these credits are high-yielding corporate bonds or debt instruments with varying degrees of credit worthiness.

“There will inevitably be losses for investors in the private-credit market, like in any investment sector,” said Seth Katz, partner and head of investments at Summit Trail Advisors in New York. “There is no substitute for strong credit underwriting.”

But Andrew Snyder, director of product and research at CAIS, an alternative-investment platform in New York City, urged “rigorous and independent investment and operational due diligence.” Such care, he said, “may be critical for financial advisors and their clients to continue reaping the benefits.”

No One-Size-Fits-All Approach
Most private-credit investors utilize professionally managed funds that are primarily made up of direct loans to small and midsized companies. These funds offer a diversity that is “a measure of protection against one deal going sideways,” said Sam Adams, a portfolio manager at Spouting Rock Alternative Credit in Darien, Conn.

There are many types. Interval funds, which are closed-end funds that periodically buy back at least 5% of outstanding shares, typically offer liquidity every quarter. Business Development Companies (BDCs) are publicly traded closed-end funds that invest in developing or distressed companies and provide “a high level of transparency and daily liquidity,” said John Kline, president and CEO of New Mountain Finance Corp. in New York.

All private-credit funds have “higher fees than traditional mutual funds and ETFs,” said Michelle Connell, owner and CIO of Portia Capital Management in Dallas. “Investors need to make sure that they're getting their money's worth.”

Experience Counts
Skilled management is key to the success of any of these funds, experts say. “Select a manager who has a long track record of delivering strong results,” advised Jon Ekoniak, a managing partner at Bordeaux Wealth Advisors in Menlo Park, Calif.

Matt Stewart, a managing director at Oaktree Capital Management, a Los Angeles-based alternative-assets specialist firm, echoed the recommendation. “Many new entrants to the market aren’t cycle-tested and may not have the expertise to manage through a market downturn,” he said. “Further, these newer entrants might not have the same access to sources of deal flow.”

Jeff Wagner, senior partner and principal at LVW Advisors in Pittsford, N.Y., agreed. “Selectivity is key to successful execution,” he said. “This is particularly important in today’s environment as higher rates put greater pressure on companies’ ability to service their debt.”

A Shadow Banking System?
Advocates insist, however, that this is not a shadow banking system that’s headed for disaster.

“Private-debt firms and their funds are structured very differently from banks,” said Dan Ziznewski, a principal at Homrich Berg in Atlanta. Banks “can have a significant amount of their deposits pulled in a matter of hours. Private debt is structured by design to be a long-term, patient, buy-and-hold asset class. So there cannot be a ‘run on the bank.’”

That does not mean there are no dangers. “Should we hit a hard recession, [private-credit] funds may struggle if there's a wave of corporate defaults,” said Jeff Fishman, founder of JSF Financial, a wealth management practice in Los Angeles. “Such funds are suitable for a very astute investor who seeks high income, is comfortable with credit risk, and understands the parameters of such an investment.”

In other words, this market is not right for everyone. You have to be “willing to invest over a longer-term time horizon with limited liquidity,” said Grishma Parekh, managing director of New York-based HPS Investment Partners and co-head of its North American core senior lending group.

Confusing Options
Adding to the confusion is the fact that there are “more than 20 different sub-strategies of private credit,” said Alexander Hart, executive managing director at Pathstone, an ultra-high-net-worth family office in Boston. “Each comes with its own set of risks and characteristics.”

Manish Valecha, head of client solutions at Angel Oak Capital Advisors in New York, said he favors residential and commercial mortgages that offer “attractive risk-adjusted yields" and are “backed by a hard asset.”

Others are wary of the hard sell that some funds employ. “I am always leery of products that solicit actively to the mass affluent market,” said Shana Sissel, founder and CEO of Banrion Capital Management in Chicago.

Such efforts, she said , suggest that “institutional investors are not allocating to the firm and, given their better due diligence capabilities, there may be a reason why.”

Double-Digit Yields Are Hard To Argue With
Nevertheless, backers of the strategy remain undeterred. The high yields alone “more than compensate investors” for the risks, said Rob Douglass, chief credit officer at Apogem Capital in New York.

Tod Trabocco, managing director at Aksia, a New York-based advisory firm focused on alternative investments, which recently launched the Calamos Aksia Private Credit & Income Fund, called private debt a “growing asset class.”

As such, there will be disparities. Time “will likely expose weaker underwriting and documentation—and potentially generate select losses and wide performance dispersion,” said Kris Mastronardi, managing director and global head of strategy at King Street Capital Management in New York.

Yet these differences may balance out. “There are now greater opportunities to hedge against or avoid challenges in particular markets or sectors,” said Nicholas Smith, managing director of private credit at the the Alternative Investment Management Association's Alternative Credit Council, a global body that represents asset management firms in the private-credit and direct-lending space.

“There will be winners and losers,” said Daniel Roe, partner, CIO, and co-CEO of CI Budros Ruhlin Roe Private Wealth, a fee-only advisor in Columbus, Ohio. “But there is opportunity in the space.”