How it works
Private credit's pitch leads with yields public markets cannot offer — 10–12% headlines against 6–7% liquid high-yield benchmarks — and the pitch is technically true and practically incomplete. Loans default, recoveries disappoint, and funds charge for the work: the honest measure is expected net yield, headline minus expected credit loss (default rate × loss severity) minus fees. The default case shows the anatomy: 11% advertised, minus a 3% default rate recovering 55 cents on the dollar (a 1.35-point expected-loss drag), minus 1.5% of fees, nets nearer 8.2% — a 2.8-point illusion between brochure and expectation, still a 1.7-point spread over the 6.5% benchmark. That residual is the actual price being paid for lockups, opaque marks and gate provisions, and deciding whether it suffices is the entire investment question. Two structural caveats complete the picture: default rates are not steady 3% drizzles but clustered droughts-and-floods — 2009 and 2020 delivered multiples of the average in single years — and valuations arrive monthly from the manager marking their own book, smoothing volatility that surfaces all at once when liquidity vanishes. Size accordingly, and demand the vintage-year track record, not the brochure yield.
Formula
Net yield = headline − (default rate × loss severity) − fees | Spread = net − liquid benchmark
Tips
- Ask for realized net IRRs by vintage year, especially 2016 and 2020 cohorts.
- Stress-test with recession default rates — 2–3× the average is historically normal.
- Compare against direct high-yield bond funds before paying private-markup fees.
- Never fund private-credit commitments from money you might need quickly.
- Diversify across managers and vintages; single-fund concentration amplifies mark risk.
Frequently asked questions
- Is private credit's high yield real?
- The coupon is real; the net is smaller than advertised. Headline yields quote gross of defaults, recoveries shortfalls and management fees — on typical inputs an 11% offer nets near 8.2%, a 2.8-point illusion. Whether the remaining spread over liquid bonds fairly compensates lockups and opacity is the genuine question each investor must price.
- How do you calculate expected loss on loans?
- Multiply probability of default by loss given default. A 3% annual default rate with 45% severity (recoveries returning 55%) produces 3% × 0.45 = 1.35 points of expected annual loss. Subtract that plus fees from the coupon to reach expected net yield. The formula is simple; estimating the inputs honestly across a full credit cycle is the hard part.
- What happens to private credit in a recession?
- Defaults spike together — historical stress years have produced default multiples of the calm-cycle average — and recovery values sag simultaneously as collateral markets thin out. Because holdings are illiquid, managers cannot rotate away, and redemption gates may lock investors entirely. Income streams built on average-case defaults routinely disappoint precisely when investors least afford disappointment.
- How does private credit differ from high-yield bonds?
- Structure and access: private deals negotiate covenants, security and pricing individually, often lending senior in the capital structure at floating rates, while high-yield bonds trade publicly with daily prices and instant exits. Net of defaults and fees the yield gap narrows substantially; the durable difference is liquidity — you are compensated for accepting multi-year lockups and smoothed, manager-marked valuations.
- What fees do private credit funds charge?
- Commonly 1–2% management plus incentive slices around 10–20% above a hurdle, sometimes wrapped inside BDC structures with their own expense stacks — total drags of 1.5–4 points occur. Fees are charged on gross coupon before credit losses, which is why the calculator subtracts them explicitly. Every fee point paid consumes a fifth of a typical net spread.