Private credit has grown rapidly in Australia over the past decade as banks have stepped back from certain types of corporate lending.
While the sector has been marketed as offering attractive yields, stability, and diversification benefits, the reality is that private credit funds carry substantial risks.
For many investors, especially those seeking reliable income or capital preservation, they may be far from suitable.
The Australian private credit market has grown in recent years and continues to grow strongly.
The size of the market is estimated at around $200 billion, approximately half of which is real estate–focused finance.
The dramatic growth of private credit has highlighted the expanding role nonbank financial institutions are playing in corporate lending.
Fund managers have moved into the gap, raising capital from institutions, high-net-worth individuals, and in some cases retail investors, to provide loans directly to businesses.
Private credit funds typically lend to businesses that cannot access bank loans.
In Australia, the major banks dominate the corporate lending market and generally reserve financing for larger, well-rated companies with strong financials.
Private credit managers tend to lend to smaller or mid-sized businesses, with less diversified revenue streams, weaker credit profiles, higher leverage, and inconsistent cash flows. These businesses may already be in some form of financial distress or restructuring. This profile inherently increases default risk.
By design, private credit managers are stepping in where banks will not tread, meaning the underlying borrowers are riskier. Investors attracted by relatively high yields need to recognise that those returns are compensation for substantial credit risk.
One of the biggest challenges with Australian private credit funds is their illiquidity.
Unlike listed equities or fixed interest securities, loans to private companies are not traded on liquid markets. There is usually no secondary market at all.
This means that if investors need to access their capital due to unforeseen circumstances, they may be unable to do so without accepting a steep discount, if any exit option exists.
During periods of financial stress, redemption requests may be suspended altogether, trapping investors until loans mature or are repaid. For investors who value flexibility or may need access to their funds in the short or medium term, this illiquidity makes private credit unsuitable.
Transparency is another area of concern.
Listed credit funds or traditional fixed income securities provide regular reporting, ratings, and market pricing.
By contrast, private credit funds in Australia often disclose very little about the identity of borrowers, the specific terms of loans, including covenants, collateral, and maturities, and how loans are valued in the fund’s accounts.
Investors are therefore relying on the manager’s self-reported valuations and performance metrics.
Unlike equities or bonds, there is no daily pricing mechanism to reflect changes in borrower quality or market conditions. This creates an “illusion of stability” in fund reporting until defaults actually occur, at which point losses can be sudden and severe.
One of many great Warren Buffet market insights is his comment that “Only when the tide goes out do you discover who's been swimming naked”.
Buffett was referring to highly leveraged businesses – like many private credit funds - when he was using this quote. He meant that you don't really know or appreciate the risks that companies are taking until they are tested by adverse conditions.
When the economy slows down and goes into recession, which it does on average around every 7 to 10 years, businesses that take on too much debt during the business cycle expansion now see a quick downturn in their revenues.
This lack of transparency is also a result of often complex layered structures in how the actual loans are held, such as the use of special purpose vehicles (SPVs) to hold loans, offshore domiciles for tax or regulatory reasons and complex fee arrangements, including management fees, performance fees, and transaction-level charges.
For the average investor, it can be extremely difficult to untangle these structures and understand where risks lie.
Complexity also increases the chance of misaligned incentives, where managers prioritise their own fees or deal pipeline over investor protection.
Unlike the banking sector, where lenders are highly regulated and capitalised, private credit in Australia is dominated by fund managers with varying levels of experience and capability. Many funds are relatively new, with limited track records across full economic cycles.
This raises several issues:
Investors are therefore not only exposed to borrower risk but also to manager competence and integrity.
In conclusion - the rise of private credit in Australia reflects both opportunity and danger.
On one hand, it fills a financing gap for businesses underserved by banks, offering higher yields to investors. On the other, it does so by taking on borrowers and structures that are inherently more risky, less liquid, and less transparent.
For investors, the promise of steady high returns often masks the reality of complex, opaque, and illiquid exposures that can unravel quickly in adverse conditions.
While private credit funds may be suitable for sophisticated institutions with deep pockets and tolerance for risk, they are not appropriate for many individual investors.
In the end, the old investment rule still applies: higher returns come with higher risks. In the case of Australian private credit funds, those risks are significant, and investors need to approach with extreme caution.