Why the ultrawealthy are beating the crowd to one of 2025's big investment trends: private credit

• Family offices are turning to private credit for equity-like risk returns.
• It's gaining momentum as a hedge against stocks and a slowing private equity market.
• Private credit offers flexible lending but carries risks like high leverage and tax burdens.

Wall Street sells what's hot. So, it's no secret that private credit is now the flavor du jour, said Paul Karger, co-founder and managing partner at TwinFocus, a $10 billion family office advisory. His firm has seen a recent uptick in underwriting for private credit strategies from, say, five years ago.

You can blame it on the perfect storm that created equity-like risk returns in the credit space. Over the past two years, the rising risk-free rate pushed up the threshold for taking on more risk. Investors began looking outside the realms of tight spreads. Meanwhile, supply rose to meet the growing demand since institutional players, hedge funds, and private equity could raise capital to chase those higher yields. All the while, banks were scaling back on lending to businesses.

"With private credit, you cut that J curve significantly because you don't need time for the investment, like on the private equity side, to mature and show some growth," Karger said. "With private credit, the borrowers typically pay out of the gate. There's a current cash component that can run anywhere from high single-digits, eight, nine, 10% all the way up to 20% type returns."

As for borrowers, private credit managers have been able to move faster and be more flexible in lending standards than traditional banks. So the deals can look attractive for both sides, Karger added.

Marcia Nelson, managing director of Freedom Family Office, who frequents her industry's conferences and hosts a few herself, says the private credit space has been the newest conversation piece over the last six months. She's seeing a particular interest in lending through the US Small Business Administration (SBA), something she attributes to a shift away from a slowing private equity market faced with fewer IPOs and prolonged returns on deals.

"One of the things I'm hearing from families is that they are moving some of their allocations out of private equity and out of direct deals into direct private credit," Nelson said. "And part of it is they're just seeing that there's really great investment opportunities, and the returns are really good."

Family offices' conservative approach and wealth preservation mandate also means they're more concerned with high equity valuations. Private credit provides an additional diversifier with uncorrelated investments that can be customized. Some managers are even lending to esoteric borrowers such as the defense sector or music rights deals, Karger noted. They can opt for investment durations as short as six months all the way up to 12 years, depending on whether it's direct lending or done through a fund manager who requires a lock-up period to recycle the capital.

But buyer beware. The risk is in the details, and in a sector that isn't pegged to fixed standards like credit ratings, they can be hard to snuff out. The team leading the fund matters. In other words, those tasked with the underwriting and due diligence should have a shared background in the industries of the borrowers they're vetting, Karger noted. The lending should be limited to sectors where there are credit needs. The fund should also have some competitive edge, such as a proprietary database or system they use to find and vet deals. And finally, the management fees must be more incentivized than fixed, Karger added.

Nayan Lapsiwala, director of wealth management at Aspiriant, emphasized that many borrowers tend to be higher risk, highly leveraged, and tied to the floating rate, making them very sensitive to shocks, especially if rates spike amid an economic downturn.

"Leverage can be on both sides and so you have to take that into account," Lapsiwala said. "The investor might also be borrowing money to invest into this, and the company that they are investing in is also highly levered. So there can be hidden leverage that people don't pay attention to."

It means that the hurdle rate, which is the minimum acceptable return before fees, shouldn't be at something as low as 5% to 6% or near the risk-free rate, said Rajesh Bansal, co-founder of private credit fund Quiq Capital.

Overall, if a manager is willing to invest in the equity of a certain company, then they're definitely willing to invest in its debt because debt is ahead of equity holders when it comes time for bankruptcy or liquidation, Lapsiwala said.

However, investors must also consider the tax burden, which could be less favorable. For non-taxable investors, such as foundations and endowments, it's a very suitable asset class. But for US-taxable investors, the returns have to be juicier to make it worthwhile, more like north of 15% to 20%, Karger said. That's because you'll get a tax bill on the gross returns and take a hit on high management fees that aren't deductible. Some of those fees are charged on the total leverage. This means an investor could pay tax on a 20% return while only receiving 12%.