What investors should ask before allocating to private credit What investors should ask before allocating to private credit

What investors should ask before allocating to private credit

Illiquidity, high fees and limited public information raise the bar for private credit allocators. Morningstar analysts discuss how the asset class has matured and how institutions can build a strategic allocation in a disciplined, rigorous way.

Private credit comes into its own

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In any rapidly growing — even trendy — asset class, the question is how to build income in a disciplined, rigorous way. There are always some investors chasing yield and treating the “shiny new” market as a quick tactical play. That can make it tricky for strategic, long-term investors to separate fundamentals from sentiment. “It brings to mind that famous old adage about how more money has been lost reaching for yield than at the point of a gun,” Lefkovitz jokes. “It is important to remember that high yield generally means high risk. Leverage can work both for you and against you. So, investors have to enter the private credit space with eyes wide open and prepared to conduct very rigorous due diligence. Credit cycles are inevitable and the potential for losses is real.” “You have to know going in that this is not a liquid product,” Dimler stresses.

“Is the data accurate? And if it’s not, is there a process to resolve that?”

Scrutiny of how private credit is valued and rated has intensified as the market has grown. But credible, credit assessment can give institutions and allocators confidence. According to Lefkovitz, independence and transparency are key. “The more tools, the more information we can provide investors, the better. But it's never going to be perfect, which is why private credit should compensate investors with extra return.” Meanwhile, Dimler sees the uniquely limited information available in private markets as what increases the needs for reliable third-party assessment. “Our philosophy is investors first. Morningstar DBRS and its predecessors have been providing reliable corporate and structured credit ratings to investors since 1976.” “It’s important to know that our approach to private credit ratings is identical to our public credit ratings, including the same methodologies and criteria,” Dimler emphasizes. “There's been some misperception in the market about how rating companies actually operate,” he continues. “Our approach looks holistically and qualitatively at a borrower’s business model, how it is positioned with respect to competitive strength and ability to deliver its products and services to customers. We also look at the quantitative side: the financial performance, the statement of condition and the operating strength to support capital needs.” Dimler’s bottom line? “It is critical to fully understand the unique nature of these assets and what risks you're buying, including availability of future liquidity. We recommend asking a lot of questions and make sure that you understand their answers.”

Finding confidence amid heightened scrutiny

In recent years, private markets investment has moved from the margins of many institutional portfolios to a core source of income. According to a CFA Institute study citing PitchBook data, private market assets under management in 2026 were six times what they were a decade earlier. As private credit has grown, so too has scrutiny of how it is valued and rated.

“Private credit filled a void left by a decline in bank lending."

“Private credit is coming into its own as an asset class,” Michael Dimler, Senior Vice President for Morningstar DBRS’ Private Corporate Credit Ratings team, observes. “It scaled in the wake of the financial crisis, when normal lending channels pulled back their capacity and willingness to lend to private equity sponsored companies. In response, an alternative financial market structure emerged that could serve that client base, which has subsequently grown considerably.” Dan Lefkovitz, a strategist for Morningstar Indexes, sees the shift towards private credit as a durable structural trend. “In terms of drivers, I think there are a few things going on," he says. “We’ve seen a profound shift in capital formation in recent years with so much lending to corporations happening outside of traditional financial institutions and public bond exchanges. Private credit filled the void left by a decline in bank lending to higher risk companies after the 2008 financial crisis.” "There's undeniably some herd behavior at work when it comes to the institutional asset allocation side,” Lefkovitz adds. “We've also seen some private markets focused funds post really spectacular returns. Investors naturally want a piece of that action.”

Dan Lefkovitz, Strategist for Morningstar Indexes

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Michael Dimler, Senior Vice President for Morningstar Credit Ratings

Dan Lefkovitz, Strategist for Morningstar Indexes

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“A private investment should be approached as a long-term relationship with the fund manager."

Michael Dimler, SVP for Morningstar Credit Ratings

Analyzing private credit is arguably more challenging for investors who have traditionally focused on public or sovereign debt because it’s less standardized, less liquid, and often less transparent. “Private credit undeniably presents unique challenges,” Lefkovitz admits. “But at the end of the day, credit research is credit research. The fundamental questions are the same, whether it's private credit or public debt. Can the borrower service the debt? Can the asset perform?” Lefkovitz sees indexing – his area of expertise – playing a critical role in helping to define the private credit space and providing investors with tools to allow them to compare and contrast investment opportunities. Dimler highlights that understanding how an investment fits into a portfolio is critical; as is proper due diligence on the investment in question. “What is the track record of the fund company or manager company? How forthcoming are they on the performance of the underlying investments? Do they have a history of putting investors first? Is there a diligent risk evaluation process and are they willing to use third parties for valuation? These are all core values that we at Morningstar prioritize.” He also warns that fees in the private credit world can be very high relative to the public side and understanding how those fee structures impact returns is also vital. According to the Morningstar research report authored by Jack Shannon, “The Cost of Incentive Fees and Semiliquid Funds,” in addition to management fees and incentive fees being higher, the latter is also not always easy to discern from prospectuses.