An Overview of Private Credit and How It Works

Private credit has emerged as a significant presence in Australia’s investment landscape, with estimates of the market size ranging from as low as A$1.8 billion to as high as A$188 billion. This remarkable growth stems from an increasing number of businesses turning to non-bank lenders for their financing needs.

At its core, private credit involves direct lending that occurs outside the traditional banking system. Unlike shares or bonds, these investments do not trade on public markets, making them somewhat more complicated to value and track. Additionally, these investments have delivered impressive returns, with US direct lending averaging about 10.1% over the past decade, compared to just 1.9% for Treasuries and 6.5% for high-yield bonds.

The private credit market in Australia has distinct characteristics, with the Australian Securities and Investments Commission (ASIC) estimating that approximately half of the $200 billion Australian private credit market is tied to real estate, primarily in construction and development. For investors, this offers a compelling combination of income and capital protection, as well as diversification benefits for those looking to enhance their portfolio yield.

This article examines how these investment techniques work, the various ways Australian investors can access these opportunities, the potential benefits and risks involved, and how to properly evaluate the funds before investing.

Understanding What Private Credit Investing Is

It represents a distinct financing approach that operates beyond the boundaries of conventional banking systems. Essentially, it involves direct lending arrangements between borrowers and non-bank financial entities. This alternative lending channel has gained substantial momentum in Australia, with estimates suggesting the overall market size ranges between A$200 billion and A$305 billion.

Definition of Private Credit vs Traditional Lending

Private credit fundamentally differs from traditional lending in several significant ways. While banks operate under strict regulatory frameworks and standardised lending criteria, it offers bespoke financing solutions tailored to specific borrower needs. The loans are privately negotiated between lenders and borrowers rather than being syndicated or sold in public markets.

The relationship structure also varies considerably. In traditional banking, loans often follow rigid approval processes with standardised terms. In contrast, private credit arrangements feature customisable terms, covenants, and pricing structures negotiated directly between parties. Furthermore, it typically delivers funding more swiftly—sometimes within days rather than weeks or months—making it particularly valuable for time-sensitive financing needs.

Another key distinction lies in the approach to assessment. Banks generally emphasise credit history and consistent cash flow, whereas private credit lenders focus more on asset value, expected returns, and overall transaction viability. This flexibility explains why it has become increasingly important for businesses with complex structures or those requiring bridging finance.

Types of Private Credit: Corporate, Real Estate, Asset-Backed

Corporate/commercial lending constitutes approximately 20-40% of the market. This segment provides direct loans to businesses across various sectors, including listed companies, unlisted enterprises, and private equity-owned firms. Corporate private credit often features tailored terms to meet specific business requirements, whether for working capital, acquisitions, or growth financing.

Real estate lending represents the most significant portion at 40-60% of the Australian private credit market. This category encompasses financing for residential and commercial property developments, construction projects, and property asset management. The significance of real estate within Australia’s private credit landscape notably distinguishes it from global markets.

Asset-backed finance (ABF) accounts for 10-30% of the market. ABF involves structured lending secured against specific pools of assets such as mortgages, consumer receivables, equipment, industrial machinery, or intellectual property. Instead of relying on a company’s overall financial health, these loans focus on the value and performance of the underlying collateral. This approach provides additional security through clearly defined asset pools that can be liquidated if necessary.

How Private Credit Funds Operate in Australia

Private credit funds in Australia function by gathering capital from various investor types, including superannuation funds, institutional investors, family offices, and high-net-worth individuals. These funds then deploy this capital through direct lending arrangements with borrowers seeking alternatives to traditional bank financing.

Most Australian private credit funds operate as open-ended structures, which contrasts with the closed-end model more common internationally. When making loans, fund managers conduct thorough due diligence on both the borrower and any underlying assets that serve as collateral. Consequently, they prioritise ensuring borrowers can service interest payments across different market conditions.

The Reserve Bank of Australia estimates that approximately 15% of loans to small and medium enterprises now originate from non-bank sources. This shift has accelerated since 2008 as regulatory changes imposed stricter capital requirements on traditional banks, creating opportunities for private lenders to fill the emerging funding gap.

While private credit encompasses various risk profiles, good private credit managers maintain diversified portfolios across multiple borrowers and industries. Notably, these investments generate income rather than capital growth, positioning them differently from equity investments, private equity, or venture capital.

How to Access Private Credit Investments

Australian investors seeking access to private credit investments now have multiple pathways available, from traditional unlisted funds to more accessible ASX-listed products. The market has evolved significantly, offering various entry points that cater to different investor requirements, including liquidity needs, minimum investment amounts, and risk preferences.

Unlisted Managed Funds vs Listed Investment Trusts (LITs)

Most investors access private credit primarily through investment funds, which pool money from multiple investors and then lend it to borrowers. These vehicles typically come in two primary forms: unlisted managed funds and listed investment trusts (LITs).

Unlisted managed funds offer direct exposure to private credit assets but often require larger minimum investments and feature limited liquidity windows. Conversely, LITs offer greater accessibility through ASX trading, enabling investors to buy or sell units at any time via standard brokerage accounts.

The key distinction lies in liquidity characteristics. While unlisted funds may restrict redemptions or impose notice periods, LITs offer daily liquidity through exchange trading. However, this advantage comes with a trade-off: LIT unit prices are subject to market volatility and may fluctuate above or below their net asset value.

For investors concerned about the inherently illiquid nature of private debt, LITs represent a practical solution. These vehicles effectively transform illiquid private credit into tradeable securities without compromising the underlying investment exposure.

Private Credit via Superannuation Funds

Australia’s superannuation sector, now exceeding AUD 6.12 trillion, has outgrown many traditional investment options. As these funds seek diversification beyond saturated infrastructure and real estate markets, private credit has emerged as an increasingly significant allocation.

Although private credit and equity instruments currently constitute a relatively small portion of superannuation portfolios, their prominence is rapidly growing as funds expand their exposure both locally and internationally. This trend reflects the sector’s need to find new investment avenues that can deliver consistent returns while effectively managing risk.

Self-managed superannuation funds (SMSFs) can likewise allocate capital to private credit as part of their fixed-income strategy. This approach can potentially enhance tax-efficient income generation, although trustees must remain mindful of overexposure to illiquid assets.

Accessing Private Credit Through ASX-Listed Products

The ASX hosts several private credit investment vehicles that combine the benefits of private lending with the liquidity of public markets. These products typically include:

• Listed Investment Trusts (LITs) – These trusts pool investor capital to build diversified private credit portfolios with specific risk-return profiles. Examples include Metrics Master Income Trust (ASX: MXT), which targets returns of the RBA cash rate plus 3.25% annually, and MA Credit Income Trust (ASX: MA1), which aims for the RBA cash rate plus 4.25%.
• Listed Investment Companies (LICs) – Similar to LITs but with a company structure, these vehicles also provide exposure to private credit strategies.

Many ASX-listed credit funds distribute income on a monthly basis, making them particularly attractive to investors seeking a regular cash flow. For instance, Metrics Credit Partners operates multiple listed funds targeting different segments of the private credit market, each paying monthly distributions.

The proliferation of these products reflects growing demand from investors ranging from pension funds to sophisticated retail investors. Moreover, with the phased abolition of the AUD 71.86 billion bank hybrid security market underway, private debt stands to benefit as income-focused investors seek alternatives.

Benefits of Private Credit Investing for Australian Investors

The appeal of private credit has grown substantially among Australian investors seeking to enhance their portfolio performance. Indeed, this asset class offers several key advantages that make it increasingly attractive in today’s investment landscape.

Higher Yield Potential Compared to Bonds

Private credit consistently delivers superior returns compared to traditional fixed-income instruments. US direct lending has averaged approximately 10.1% over the past decade, markedly outperforming Treasuries at 1.9% and high-yield bonds at 6.5%. This yield premium primarily stems from the illiquidity premium, which compensates investors for committing capital over extended periods.

Private credit funds often target returns of cash plus 3% per year or higher, which can rival equity-like returns without the corresponding volatility. This performance differential becomes especially pronounced during periods of market stress, when private credit has demonstrated greater resilience than traditional fixed income.

Diversification Benefits in a 60/40 Portfolio

Beyond yield enhancement, private credit offers valuable portfolio diversification. Specifically, its lower correlation to traditional asset classes creates opportunities to improve overall portfolio efficiency.

Within the context of a classic 60/40 portfolio (growth/defensive assets), private credit serves as an effective complement to traditional allocations. Some investment specialists advocate for a 40/30/30 allocation of equities, bonds, and alternatives, with 10% dedicated explicitly to private credit. This approach potentially enhances portfolio robustness through improved diversification and inflation protection.

Analysis shows that portfolios incorporating high-quality alternative investments alongside traditional assets have demonstrated superior performance. During the recent five-year periods, portfolios with alternative allocations generated returns nearly double those of traditional 60/40 portfolios.

Regular Income Generation and Reduced Volatility

Private credit investments typically provide consistent cash flows through regular interest payments. This income-generating characteristic makes them particularly suitable for investors prioritising steady returns, especially retirees seeking portfolio stability.

Furthermore, private credit exhibits lower volatility compared to equities while still delivering competitive returns. This reduced volatility stems partly from private market investments being less susceptible to short-term fluctuations, pricing distortions, and sentiment-driven trading activity that characterise public markets.

The combination of regular income distribution and smoother return profiles offers defensive characteristics that become especially valuable during market turbulence. Even more conservative private debt managers maintain higher credit risk through their portfolios than traditional bond or credit managers, highlighting the importance of understanding the risk-return profile.

How to Evaluate a Private Credit Fund Before Investing

A thorough evaluation of private credit opportunities requires diligent research and careful scrutiny. Given the lack of standardisation across the market, investors must examine specific factors to identify quality managers and appropriate investment strategies.

Understanding Lending Strategy and Asset Types

Initially, determine exactly which part of the private credit spectrum the fund targets. Private credit encompasses diverse strategies—from senior direct lending to distressed debt and specialty finance—each with unique risk-return profiles. Appropriately, examine whether the fund focuses on corporate lending, real estate finance, or asset-backed securities, as this composition significantly affects both the potential for performance and downside protection. Examine loan-to-value ratios, security structures, and whether loans are first-ranking or subordinated.

Reviewing Diversification Metrics and Credit Quality

Adequate diversification remains crucial for mitigating concentration risks. Examine whether the portfolio maintains balanced exposure across sectors, geographies, and borrower types. Quality managers provide comprehensive information about loan numbers, sizes, and maximum exposures to individual sectors. Furthermore, verify how credit risk is assessed—whether through internal ratings or independent frameworks. Scrutinise the correlation between seemingly unrelated exposures, as superficial classifications can mask hidden relationships between assets.

Checking Valuation Policies and Performance Reporting

Valuation practices fundamentally determine the accuracy of investment performance reporting. Seek managers conducting regular valuations—ideally monthly or quarterly—with appropriate independence. Quality funds employ consistent methodologies that conform to fair value standards and undergo external validation. Additionally, verify how impaired loans are identified and valued, as delayed recognition of troubled assets can misrepresent performance.

Importance of Product Disclosure Statement (PDS)

The PDS constitutes an essential document revealing critical information about fund operations. Carefully review fee structures, identifying any retained borrower fees or hidden charges. Investigate governance arrangements, with a focus on how conflicts of interest are managed, particularly in relation to related-party transactions. Certainly, examine liquidity provisions, including redemption terms and historical ability to meet withdrawal requests. Ultimately, transparent disclosure practices generally indicate responsible management.

Conclusion – Private Credit

Private credit investing has carved out a significant position in Australia’s investment landscape, with the market size reaching substantial figures between A$200 billion and A$305 billion. This alternative asset class offers compelling advantages for investors seeking enhanced portfolio performance beyond traditional options.

The market presents three distinct segments – corporate lending, real estate financing, and asset-backed securities – each providing different risk-return profiles. Australian investors can access these opportunities through various channels, including unlisted managed funds, listed investment trusts, superannuation allocations, and ASX-listed products.

Private credit delivers several key benefits that explain its growing popularity. Foremost among these advantages stands its higher yield potential compared to traditional fixed-income investments. Additionally, private credit provides valuable diversification benefits within investment portfolios, potentially improving overall efficiency and resilience during market fluctuations—the regular income generation further appeals to investors prioritising steady returns, especially retirees seeking portfolio stability.

Though certainly not suitable for all portfolios, private credit represents a maturing asset class that warrants consideration from investors seeking yield enhancement and diversification beyond traditional investments. As regulatory landscapes evolve and market dynamics shift, private credit will undoubtedly continue adapting while maintaining its distinctive position between traditional fixed income and more aggressive investment approaches.

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