Private credit: Is the illiquidity premium still worth it?

The private credit market has more than doubled the growth rate of the broader asset management industry over the last decade.¹ This rapid expansion is, in large part, due to the appeal of the asset class’s historical illiquidity premium. However, today’s uncertain and volatile market has many asset owners increasingly valuing liquidity. 

Here, we dive into the crux of the matter: is private credit’s incremental yield still worth it?

What is private credit’s illiquidity premium?

Private credit premia vary over time and across subsectors of the market. This premium compensates for the asset class’s illiquidity risk, as well as for its complexity, factor, idiosyncratic, and other risks. Common allocations like direct lending have historically exhibited a 4%+ return premium relative to similar below-investment-grade public markets.² However, our multi-asset strategists use a more conservative go-forward estimate of 2% for broad private debt allocations. Critically, private credit allocations also have potential benefits like increased portfolio resilience and diversification. 

Evaluating private credit in volatile markets

Whether it is 2% or 4%+, asset owners need to consider the current liquidity trade-off when evaluating the merits of private credit’s potential premium. In our view, the resulting question “Is the illiquidity premium worth it?” is actually three different questions: 

1. What subsectors’ return premia are particularly attractive going forward? 
2. Can you handle the illiquidity necessary to access those premia?
3. How can private credit’s unique features help mitigate the risks?

We believe asset owners are best served by thinking through three implementation considerations to answer these questions.

1. Consider areas with above-average forward-looking premia

One approach asset owners can take to navigate the current market uncertainty is to demand an above-average premium to invest in private markets. Portions of the private credit market have experienced spread compression but there are numerous pockets where the spread is attractive relative to history. 

For example, the public US corporate credit market is notably tight and the investment-grade private credit market is significantly less so. Moreover, at the 74th percentile, investment-grade private credit’s spread premium relative to the public market is wide relative to history. We believe focusing on allocations with this level of premium can significantly enhance the value proposition.

2. Do the math on your liquidity needs (and consider a liquidity buffer)

While private credit allocations have increased across the board by investor type in recent years,³ the magnitude of the allocation varies based on asset owners’ distinct needs and tolerance for illiquidity. As an example, allocators that are liability or regulatory driven (e.g., pensions and insurance) may have a higher budget for illiquidity as they are generally focused on maximizing yield per unit of risk. In contrast, those that are more tactical (e.g., foundations and family offices) may seek the highest absolute return from illiquidity. When market volatility and uncertainty are high, it is critical for asset owners to refresh their outlook for upcoming liquidity needs. We believe modeling cash-flow scenarios and stress testing market outcomes can help mitigate the uncertainty and frame potential impacts. 

Importantly, by accessing parts of the asset class with an above-average forward-looking premium to public markets, asset owners have the potential to build in a liquidity buffer that helps them navigate the asset class’s illiquidity risk during periods of heightened market uncertainty. 

For example, an asset owner with a long-term ability to accept illiquidity but near-term questions about the market could decide to hold 25% of their intended private credit allocation in cash as “dry powder.” This approach would reduce the near-term yield but ensure higher portfolio liquidity (Figure 1). Notably, it provides a case study on the value of the private market yield premium in different private credit subsectors. Growth lending still offers a 3% premium to public markets when holding a 25% cash buffer, allowing asset owners to achieve the 2% – 4% premium that is often targeted in allocation decisions. However, a similar cash buffer would shrink direct lending’s historical premium to 0.1%, which may not be sufficient for some investors in the current environment.

Figure 1

3. Tap into private credit’s unique features

Finally, private credit has several additional features that can be beneficial in uncertain markets. Understanding these levers can help asset owners be selective on the strategies and managers that may best fit their goals in the current market. In our view, there are three key features to emphasize in today’s private credit allocations:

• Covenants: Public corporate credit markets currently offer lower-than-average historical credit spreads. This could lead to increased volatility in the future, with credit stress potentially magnified by today’s starting point of rich valuations. Against this backdrop, credit-protective covenants available in the private credit market — such as requirements to maintain leverage ratios below a certain level, to keep liquidity above a certain level, or to limit the ability to take on new debt without the lenders’ consent — could be valuable ways to mitigate credit stress. 
• Rate floors: One driver of the tight credit spreads referenced above is the increase in US Treasury rates over the past two years. There is a flip side to this coin, however. Many private credit instruments are floating-rate debt and deliver coupon rates that are based on a base rate — such as SOFR or Prime — plus a pre-agreed spread. The negotiated nature of the private credit market allows for investment managers to include “floors.” These are contractual provisions that guarantee a minimum base rate to protect asset owners from falling interest rates and effectively “lock in” the benefits of a higher-rate environment.
• Diversification potential: As private credit markets continue to lend to a wider set of collateral, size, and quality profiles, asset owners can diversify within their private credit allocations. This is particularly important in the current environment since public credit spreads are in the 18th percentile for the trailing 15 years, potentially increasing the credit risk in many asset owners’ portfolios.⁴ For example, asset owners can consider complementing traditional corporate debt exposure with less-correlated asset-backed lending in areas like commercial real estate debt, infrastructure debt, and asset-based finance. Amid today’s volatility, we believe that different subsectors will experience distinct drivers over shorter periods. Diversification can enhance the asset class’s value proposition beyond return premia by creating more resilient private credit allocations.

Emphasizing strategies and managers that demonstrate strong covenant discipline, that include floors, and that increase the allocation’s diversification potential can all help make the illiquidity worth it.

Bottom line on private credit in uncertain markets

Asset owners with the capacity to accept some illiquidity can continue to benefit from private credit’s return premium (and other potential benefits) despite market uncertainty. However, we believe today’s volatility necessitates a thoughtful approach to allocating to this illiquid asset class. We recommend that asset owners reassess their liquidity needs and stress test potential market outcomes. 

Critically, asset owners can tilt allocations to parts of the private credit market that provide the most relative compensation for the illiquidity, that fit best with their updated liquidity needs, and that tap into the other potential benefits of the asset class.

¹Sources: Preqin as of 2 June 2025. All figures are nominal, 2024 data is a Preqin forecast. BCG, Global Asset Management Report 2025. Private credit has grown at a 13.6% CAGR from 2014 – 2024, compared to a 6.5% AUM growth rate for the asset management industry (excluding privates). | ²Sources: Cliffwater Direct Lending Index, Bank Loan Index Splice, and Bloomberg US Corporate High Yield Index. Data for the last 15 years ending 31 March 2025. Bank loan splice represents S&P UBS Leveraged Loan Index from 2Q10 – 3Q11, Bloomberg US High Yield Loans Performing Index from 4Q11 – 2Q16 and Morningstar LSTA Leveraged Loan Index from 3Q16 to present. Past results are not necessarily indicative of future results. | ³Source: Private Debt Investor. Data as of 31 December 2024. | ⁴Source: Bloomberg US Aggregate Corporate Index. Data as of 31 March 2025.