Edward Quince's Wisdom Bites: The Other PC

 

Private credit is having a moment. Depending on who you ask, it’s either the smartest corner of modern finance or the place where risk goes to put on makeup. In late January 2024, we flagged a piece by Laurence Siegel asking the uncomfortable but necessary question: is private credit a “golden moment,” or is it just the latest incarnation of volatility laundering?

The sales pitch is elegant. Private credit promises equity-like yields with bond-like stability. Returns arrive steadily. Drawdowns are rare. Correlations appear low. And best of all, prices don’t move around much. What’s not to like?

Well… reality.

The Volatility You Don’t See Still Exists

Private credit’s defining feature is not lower risk — it’s infrequent price discovery. These assets are not marked to market daily like public bonds or equities. Their valuations are typically model-based, manager-determined, and updated quarterly — sometimes with a healthy dose of discretion.

This creates a dangerous illusion:

If the price doesn’t move, the risk must be low.

But that logic confuses accounting smoothness with economic safety.

As we’ve said before: when you can’t sell an asset, its price is theoretical until proven otherwise. The absence of volatility does not mean the absence of risk — it often means the risk is simply unobserved.

History is not kind to assets that advertise stability during periods of abundant liquidity. We’ve seen this movie before:

• AAA-rated mortgage tranches in 2006
  
  

• Auction-rate securities in 2007
  
  

• “Low-volatility” credit strategies in 2019
  
  

They all worked — right up until they didn’t.

Too Much Capital, Not Enough Discipline

Another warning sign: flows.

Private credit has absorbed enormous amounts of capital as investors, starved for yield, move “off the run” in search of income. But capital is not neutral. When too much money chases too few deals, underwriting standards don’t tighten — they relax.

Covenants weaken. Structures stretch. Sponsor-friendly terms proliferate. Risk migrates quietly from borrower to lender while reported returns remain placid.

This is Minsky in slow motion. Stability begets confidence. Confidence begets leverage. Leverage begets fragility.

Private credit is not inherently bad. In fact, it can play a legitimate role in diversified portfolios. But when the primary marketing feature of an asset class is how calm it looks — rather than how resilient it is under stress — caution is warranted.

Portfolio Construction Reality Check

Private credit should be treated like what it is:

• Illiquid
  
  

• Cyclical
  
  

• Sensitive to credit quality
  
  

• Dependent on manager skill
  
  

If it’s being used as a bond replacement, investors should ask:

Would I still like this if prices were marked honestly every day?

If the answer is no, the stability may be doing more psychological work than financial work.

The Financial Takeaway

Be skeptical of asset classes whose appeal rests on opacity rather than robustness. Stability that comes from illiquidity is not protection — it’s deferred volatility.

Private credit is not fool’s gold by default. But in late-cycle conditions, with capital flooding in and discipline eroding, it is precisely the kind of asset that looks safest just before it isn’t.

XTOD:
"Private Credit is Having a “Golden Moment” – Buy or Sell?