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Investment Management

Understanding Private Credit’s Rapid Growth

Oct 3, 2025

Private credit, which can offer floating interest rates that increase in tandem with benchmark rates, has seen significant growth in recent years and could become a $5 trillion market by 2029. See how.

Demand for private credit—which refers to lending to companies by institutions other than banks—has grown significantly in recent years. Unlike most bank loans, private credit solutions can be tailored to meet borrowers’ needs in terms of size, type or timing of transactions. Similar to bank loans, however, the majority of private credit lending is in the form of floating-rate investments that change as rates change, providing real-time interest rate protection compared to investments like fixed-rate bonds. 

 

In addition, increased market volatility and bank lending regulations have helped fuel further growth in private credit in recent years, as some borrowers have flocked to its price certainty and speed. The size of private credit at the start of 2025 was $3 trillion, compared to about $2 trillion in 2020, and it is estimated to grow to approximately $5 trillion by 2029.1

 

Ashwin Krishnan, Head of North America Private Credit at Morgan Stanley Investment Management, explains the different types of private credit, the growing appetite for the asset class and how private credit has behaved in prior market cycles.

Q
What is private credit and what are the different types?
A

Private credit is a form of lending outside of the traditional banking system, in which lenders work directly with borrowers to negotiate and originate privately held loans that are not traded in public markets. Following the Global Financial Crisis (GFC) in 2008, and the associated capital rules for banks, private credit has filled a lending void. 

 

There are generally five common types of private credit2:

  • Direct Lending: Direct lending strategies provide credit primarily to private, non-investment-grade companies. Direct lending strategies may be appealing as they invest in the senior-most part of a company’s capital structure, which may provide steady current income with relatively lower risk.   

  • Mezzanine, Second Lien Debt and Preferred Equity: These three forms of credit, collectively known as “junior capital,” provide borrowers with subordinated debt. This kind of instrument is not secured by assets and ranks below more senior loans for repayment in the event of a default or bankruptcy. Junior capital often comes with equity “kickers,” which are incentives that may support attractive total returns—often on par with equities—while still being a debt claim in the payment waterfall. 

  • Distressed Debt: When companies enter financial distress, they work with existing distressed debt investors to improve their prospects through operational turnarounds and balance sheet restructuring. Distressed debt is highly specialized and the prevalence of opportunities tends to coincide with economic downturns and periods of credit tightness. These lenders take on a higher level of risk in exchange for lower prices and potentially high returns.

  • Special Situations: Special situations can mean any variety of non-traditional corporate event that requires a high degree of customization and complexity. This may include companies undergoing M&A transactions or other capital events, divestitures or spinoffs, or similar situations that are driving their borrowing needs.

  • Asset-Based Finance: Incorporating a wide range of strategies that target assets as opposed to operating companies, asset-based finance includes loans on real assets, such as real estate and infrastructure; pools of assets such as equipment and fleet financing; or balance sheet assets of financial intermediaries such as student loans, credit card receivables or account receivables held by non-financial companies. 

 

Q
What is the role of private credit in a portfolio?
A

Investors have increasingly added private credit to their portfolios as a potentially higher-yielding alternative to traditional fixed-income strategies. It can potentially include the following:  

 

  • Current income: Like traditional fixed income, private credit generally offers the possibility for current income from contractual cash flows (i.e., interest payments and fees).

  • Illiquidity premium: Private credit may provide a yield spread above public corporate bonds to compensate for the “illiquid” or non-tradeable nature of the investments.

  • Historically lower loss rates: Private credit has demonstrated lower loss rates relative to public credit over time.

  • Diversification: Private credit has been less correlated with public markets than other asset classes, such as equities and bonds. This can help reduce portfolio volatility and improve risk-adjusted returns.

  • Customized portfolio construction: It may be possible to create highly customized portfolios of strategies to blend risk-adjusted returns across a variety of private-credit strategies. 

     

     

Q
How have returns for private credit compared to those of traditional fixed-income investments?
A

Private credit has historically offered compelling performance in relation to other segments of the fixed-income market and leveraged finance. Over the last 10 years, when private credit began to grow in earnest, it has provided higher returns and lower volatility compared to both leveraged loans and high-yield bonds.3,4

 

 

10-Year Returns Relative to Volatility - Private Credit vs. Public Markets 3, 4

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Within private markets, private credit has delivered strong risk-adjusted returns relative to private equity, venture capital, real estate and other real assets such as infrastructure.5

10-Year Returns Relative to Volatility - Private Credit vs. Other Private Markets 5

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Private credit tends to outperform in rising-rate environments, owing to its floating rate loans. During seven periods of rising rates since 2008, returns in direct lending (private credit’s largest strategy) averaged 11.6% - two percentage points above its long-term average.6  Above-average performance can also be achieved during a period of moderately declining interest rates. Direct lending posted an annualized return of 10.5% in the fourth quarter of 2024, beating high-yield bonds and leveraged loans, even while the Federal Reserve was cutting rates. If the next set of Fed cuts is shallow, or 100 to 150 basis points in total, that may be an environment in which private credit can continue to deliver compelling returns. 

 

 

Direct Lending Fared Well During the Shallow Rate Cuts of 4Q 2024 7

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Private credit may also offer better risk management against losses. Privately held companies often do not have credit ratings or, if they do, are rated below investment grade. Direct lending can be more conducive to proactive engagement with borrowers. That, combined with a greater focus on senior secured loans, may produce lower credit losses relative to the broader leveraged finance space. Senior direct lending, for example, has sustained losses of 0.4% since 2017, compared to losses of 1.1% for leveraged loans and 2.4% for high-yield bonds.8

 

 

Direct Lending at the Top of the Stack Can Produce Lower Losses4, 7

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8 Years Annualized Loss Rate
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Q
Where do you see opportunities in the private credit market?
A

We see the potential for opportunities in the following areas:

  1. Direct lending that stays true to a senior secured focus may do quite well in a soft economic landing aided by shallow rate cuts. Direct lending is highly geared to private equity deal flow, and lower rates are likely to stimulate that activity and demand for leveraged buyout loans. Significant pent-up demand and private equity dry powder that has built up over the years may create favorable lending conditions and pricing for direct lenders once fully released. 
  2. Providing junior capital and hybrid capital solutions: The growing popularity of continuation funds is driving strong demand for these structures. A continuation process will often run a tender offer to cash out legacy investors or need extra funding to supplement what secondary investors are willing to pay, and junior capital is often used to fill the gaps without diluting equity. The number of aging private equity funds stepped up dramatically in 2025 and will remain elevated for several years, and they are prime candidates for hybrid capital and continuation solutions.
  3. Rescue-financing capital, should the economy enter into a recession or high-default environment. 

 

Q
What are the key considerations for private debt in a difficult macroeconomic environment?
A

A proactive approach has become increasingly important, which includes closely analyzing companies’ earnings and free cash-flow generation in light of the current economic and interest-rate environment. Private credit borrowers are typically domestically focused, but the impact from tariffs is another important overlay.

Meanwhile, for companies, the primary focus is liquidity management. Borrowing costs have eased since the first set of Federal Reserve rate cuts in 2024 but remain significantly above levels preceding the inflation shock of 2022. To date, the vast majority of borrowers have been able to successfully manage their liquidity.

 

 

Sources & Disclosures

Sources

1 PitchBook. As of May 2025.

2 Estimates, opinions, and other forward-looking statements set forth herein are based on assumptions that Morgan Stanley believes to be reasonable as of the date hereof, including the analysis of historical trends, current conditions and expected future developments. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual results to differ from those expressed or implied by such forward-looking statements. The opinions of Morgan Stanley expressed herein reflect the current opinions of Morgan Stanley as of the date appearing in this material only. There can be no guarantee that views and opinions expressed by Morgan Stanley will come to pass. Represents the views of Morgan Stanley professionals based on their industry experience and understanding of the broader private credit market. There is no guarantee these trends will continue.

3 Data represents the 10-year period from Q1’15 to Q1’25, calculated as annualized average returns net of fees divided by volatility. Volatility is measured using standard deviation and has been unsmoothed in the case of Private Credit to remove the artificial effects of delayed reporting of fair value fluctuations.

4 “Private Credit” is represented by PitchBook’s Private Debt Index of closed-end fund returns, net of fees, and is calculated from quarterly data which has been unsmoothed and annualized. “High Yield Bonds,” “Corporate Bonds,” US Treasuries,” and “Bank Loans,” are represented by Morningstar’s US High-Yield Bond, US Corporate Bond, US Treasury Bond and LSTA Leveraged Loan series of indices. Returns and volatility are calculated from quarterly data, which have been annualized.

5 Data represents the 10-year period from 1Q ’15 to 1Q ’25. All private market categories are represented by PitchBook’s Private Capital Index of closed-end fund returns, net of fees, for the corresponding strategy. Calculated from quarterly data which has been unsmoothed and annualized.

6 Rising rate environments are defined as periods of uninterrupted monthly increases in the 10-year US Treasury yield of 75 basis points or more.

7 Source: Morningstar US High Yield Bond Index, Morningstar LSTA US Leveraged Loan Index, Cliffwater Direct Lending Index (CDLI). Long-term average represents annualized return for the 20 years ending December 31, 2024.

8 Source: PitchBook LCD, Cliffwater, Moody's, S&P Global, Morgan Stanley Investment Management. Leveraged loan and high yield loss rates are calculated from annualized data between 2017 and 2024 and use the following formula: LTM default rate * (1 minus – average recovery rate). Default rates for leveraged loans are based on PitchBook LCD data and include distressed exchanges. Recovery rates for leveraged loans are based on S&P Credit Pro data. Default rates for high yield bonds are based on Moody’s data and include distressed exchanges. Recovery rates for high yield bonds are based on Moody's data. Credit losses for senior direct lending are based on annualized data between 2017 and 2024 from the Cliffwater Direct Lending Index – Senior (CDLI-S) using reported net losses (realized) adjusted for estimated imbedded gains. Using the broader Cliffwater Direct Lending Index (CDLI), which is representative of both senior and non-senior loans originated for middle market borrowers, would produce an estimated annualized loss of 1.33%.

 

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