Private credit vs. public credit: Understanding the key differences and benefits
Understand the difference between private and public credit, including the benefits of each option.
Private credit and public credit represent two distinct segments of the global credit market. While both serve the same fundamental purpose, which is to provide capital to borrowers while generating consistent returns for investors, they differ significantly in structure, accessibility, and their risk and return profile.
In this private credit vs public credit comparison guide, we’ll break down how the two asset classes stack up against one another so investors and borrowers alike can decide which is the better option for their needs and circumstances.
Understanding private and public credit
What is private credit?
Private credit refers to corporate lending that takes place outside the traditional banking system and public markets. It occurs between private investors and companies that prefer not to issue debt publicly. Non-bank lenders such as private debt funds, asset management firms, and business development companies (BDCs) often provide this type of credit.
Private credit is most commonly used by SMEs or middle-market firms that may have problems securing commercial bank loans due to their size, credit profile, or complex business models. Transactions are typically negotiated privately and often feature customized terms tailored to the specific needs of both the lender and the borrower.
As an asset class, private credit has gained popularity in recent years, particularly among middle-market companies looking for customized financing solutions and investors seeking higher yields than what’s currently being offered by bank loans and public debt, fueling the rapid expansion of the private debt market.
What is public credit?
Public credit refers to debt instruments, such as corporate bonds, that are issued and traded on public markets.
Larger, more established companies seeking capital from a wide pool of investors generally offer these instruments. Public credit is subject to extensive regulatory oversight, and details such as interest rates and maturity dates are publicly disclosed and accessible through open markets.
Private credit vs public credit: Key differences
Let’s look at some key differences between private and public credit.
Investor access
Public credit is available to both institutional and retail investors through platforms like bond markets or mutual funds. In contrast, private credit is generally limited to institutional investors such as private debt funds, mainly due to high minimum investment thresholds and the fact that there’s no open market for this asset class..
Standardization vs customization
Public debt instruments are typically standardized. This standardization allows for efficient trading and widespread accessibility. However, it also limits the ability to tailor loan terms to the specific needs of individual borrowers.
Private credit, on the other hand, offers greater customization. Loans can be structured to meet borrowers’ unique requirements, including flexible repayment schedules. For instance, a growing company seeking financing for a specific project might require a loan with a unique repayment structure that aligns with its projected cash flows. Private credit lenders can accommodate such needs.
Transparency and regulation
Public credit is highly regulated. Issuers are required to disclose financials, credit ratings, and material updates on a regular basis, which translates to high transparency for investors.
Private credit operates in a more opaque environment. Detailed financial information may not be publicly accessible, and valuation may rely on third-party assessments. This lack of transparency increases the complexity of analyzing and monitoring private credit investments.
Liquidity
Public credit boasts high liquidity, meaning it’s relatively easy for investors to exit their investments. Private credit, on the other hand, is highly illiquid. There’s limited secondary market activity for the latter, and investors must be ready to commit their capital for multiple years (typically 5-10 years).
Risk and return profile
Private credit tends to carry higher risks than its public counterpart. This is primarily due to lower liquidity in private credit instruments. Additionally, private credit deals often involve smaller, less-established companies, which can increase the potential for default. To compensate for these increased risks, private credit typically offers higher yields.
Conversely, the yields of public credit are lower due to its higher liquidity and the fact that it generally involves lending to larger, more established firms, which have a lower risk of default.
Benefits of private credit
Private credit offers several benefits for both investors and borrowers.
Investors
For investors, the biggest benefit of private credit is the potential for enhanced returns. As mentioned, this asset class offers higher yields to compensate for its illiquidity and the overall higher risk of investments. For example, while investment-grade corporate bonds may yield 3–6%, private credit strategies (such as direct lending or mezzanine financing) often deliver 8–12% or more in annual returns. The Cliffwater Direct Lending Index (CDLI), for example, returned 12.13% in 2023 and has delivered a 9.55% annualized total return since its inception in 2004.
The other benefit is diversification. Private credit allows investors and managers to diversify their portfolios beyond just traditional equity or public debt. It has low correlation to public markets and can therefore act as a hedge against market volatility.
Finally, private credit allows investors to negotiate and tailor debt arrangements to align with their specific risk and return objectives.
Borrowers
Private credit provides a crucial source of capital for borrowers who may face challenges securing financing from traditional sources like banks. In particular, private debt financingenables businesses to structure deals quickly and confidentially, often on terms that align more closely with their unique operational and financial needs.
Private debt deals can also be completed faster, which is especially valuable in time-sensitive situations. Furthermore, unlike public debt, which requires detailed disclosures, private debt transactions are typically confidential. This allows borrowers to avoid disclosing sensitive information, which could impact their competitive position or market perception.
Benefits of public credit
Just like private credit, private credit also has its benefits for both investors and creditors.
Investors
Since public credit instruments, like corporate and government bonds, can be traded easily in secondary markets, this allows for quicker investor portfolio adjustments in response to changing market conditions or investment objectives.
Additionally, public disclosure requirements associated with public credit instruments make it easier to assess the relative value and potential worthiness of an investment.
Borrowers
For borrowers, public credit markets enable businesses to raise large amounts of capital efficiently from a broad investor base. Additionally, successfully issuing and managing public credit can enhance a borrower’s credibility, visibility, and creditworthiness in the eyes of stakeholders. The transparency and oversight involved can signal to the market that the company is financially sound and can meet its obligations.
Finally, for investment-grade issuers, the cost of capital in public markets is typically lower than private debt due to the lower perceived risk from public scrutiny and the liquidity offered to investors.
Final thoughts: Choosing between private credit and public credit
Private and public credit play important roles in the debt financing ecosystem. But as seen, they offer quite different value propositions for both investors and borrowers. Private credit stands out for its flexibility and potential for higher returns. It appeals to long-term investors willing to accept illiquidity and higher risk for the chance of greater rewards.
On the other hand, public credit offers greater liquidity, accessibility and a lower-risk profile. It is a better fit for investors who prioritize ease of entry and exit, transparency, and standardized terms.
Ultimately, choosing between private and public credit comes down to your investment objectives, risk appetite, and time horizon. By understanding what each option brings to the table, you can make more informed decisions and build a well-balanced credit strategy. Many sophisticated investors choose to incorporate both into their portfolios to balance risk and maximize returns.
For fund or asset managers looking to unlock the full potential of private credit, Alter Domus offers specialized solutions that support every stage of the private credit lifecycle, from fund structuring and loan administration to data analytics and investor reporting.
Learn how private debt funds work and the role of debt asset management.
Private debt has become one of the fastest-growing segments of the alternative investment landscape. Once considered a very niche strategy, it has slowly gained mainstream acceptance, particularly among institutional and other sophisticated investors seeking higher yields and greater control over risk compared to traditional debt markets and other alternative asset classes, like private equity or venture capital.
The increased appetite and acceptance has led to a spike in private debt finds launched.
In this guide, we’ll tell you everything you need to know about private debt funds including how they operate, how they are structured, and some of the key strategies they employ to manage risk and generate value for investors.
What is a private debt fund?
Private debt, also known as private credit, refers to the provision of debt financing to borrowers through channels other than traditional banking institutions or public markets. So rather than securing loans from banks or issuing publicly-traded bonds, businesses borrow the funds needed to support growth, refinance existing debt or fund acquisitions and current operations from private lenders. Understanding the differences between private credit vs. public credit is essential to grasp how this asset class fits into a diversified investment strategy.
One of the primary sources of this type of lending is private debt funds. These are pooled investment vehicles that gather capital from a range of investors, including institutional investors (such as pension funds, insurance companies, and endowments) and high-net-worth individuals. The fund then strategically deploys this pooled capital to provide diverse forms of debt financing to companies.
Unlike public credit investment vehicles, which are traded on open markets, private debt is privately negotiated between the lender (the private debt fund) and the borrower (the company). This allows the lender and borrower to tailor the terms of the loan or debt facility to the specific needs of both parties.
Returns for investors in private debt funds primarily come from interest payments on the fund’s portfolio of loans. The rates charged depend on factors such as the borrower’s creditworthiness, the type of debt issued, and the prevailing market conditions.
But generally, the illiquid nature of private debt and the fact that they are typically extended to borrowers with more complex financing needs, such as middle-market companies or those lacking access to conventional financing, means they typically command higher rates to compensate for the higher risk and/or custom terms.
What’s more, most private debt also comes with a floating rate that’s pegged to a base rate, such as the Secured Overnight Financing Rate (SOFR), which offers investors potential protection against rising interest rates.
Why have private debt funds become popular?
Private debt funds rose to prominence following the 2008 global financial crisis. As banks came under tighter regulatory scrutiny and adopted more conservative lending practices, a financing gap emerged, particularly for middle-market firms and other businesses with riskier credit profiles.
Private debt funds stepped in to fill this void, positioning themselves as a vital alternative to traditional lending.
In the years following the financial crisis, persistently low interest rates (that meant low yields on traditional bonds and savings products) further pushed investors towards private debt as an alternative.
The end result has been exponential growth in this sector. Private debt assets under management have surged from just over $300 billion in 2010 to over $1.8 trillion currently. According to Preqin, this figure is projected to reach $2.64 trillion by 2029.
Benefits of private debt
Let’s look at some of the primary benefits of private debt for investors.
Potential for enhanced returns: Private debt often offers the potential for higher risk-adjusted returns compared to traditional fixed-income investments. This is largely due to what’s known as the illiquidity premium, which is the additional return investors demand and receive for holding assets that cannot be easily sold or traded in the short term. Since private debt investments are typically long-term and not publicly traded, investors are compensated with higher yields.
Diversification benefits: Private debt offers portfolio diversification by providing access to an asset class that tends to behave differently from publicly traded investments. They can act as a stabilizing force against market volatility in a broader investment portfolio.
Customization and risk control: Managers of private debt funds possess greater control over the terms of the loans they originate. This enhanced control allows them to better manage credit risk and tailor each investment to specifically meet the fund’s desired risk-return profile.
Types of private debt funds
Private debt funds come in various forms. Let’s look at the most common types.
Direct lending funds
Direct lending is the most common form of private debt, accounting for about 44% of overall assets under management (AUM). It involves providing loans directly to middle-market companies. These loans usually take the form of senior secured debt, meaning they are backed by the borrower’s assets and have priority in repayment if default occurs. However, they can also take other forms, such as unitranche loans (combining senior and subordinated debt).
Distressed debt funds
These funds invest in the debts of companies facing financial difficulties. The objective here is to purchase debt at a discount, with the potential to realize significant gains if the company’s fortunes improve or through restructuring initiatives.
Mezzanine debt funds
Mezzanine debt is a hybrid form of financing that offers both debt and equity-like features (e.g., equity warrants or conversion rights). In the capital structure, it sits between senior debt and equity and therefore carries higher risk. Accordingly, mezzanine debt offers higher returns to compensate for this increased risk.
This type of debt is commonly used in leveraged buyouts and other acquisition financing. For corporate borrowers, mezzanine debt is attractive because it provides growth capital without diluting ownership significantly or imposing the restrictive covenants of senior loans.
Special situations
Special situations investing involves deploying debt capital in companies undergoing unusual or complex events that create opportunities for value realization. These events might include restructurings, asset sales, spin-offs, regulatory changes, or shareholder activism. Unlike distressed debt, which deals with troubled companies, special situations may involve fundamentally sound businesses facing temporary disruptions or strategic shifts.
The goal is to capitalize on the inefficiencies caused by these unique circumstances and profit when things settle down. The approach is highly opportunistic and requires deep due diligence and a hands-on style. However, the returns for special situations debt funds can be high due to limited competition and borrower urgency.
How private debt funds are structured and managed
Private debt funds are often set up as limited partnerships comprising two main stakeholders.
Limited Partners (LPs)
These are investors committing capital to the fund. As mentioned, they include institutional investors, like pension funds, insurance companies, and endowments, and high-net-worth individuals. LPs have limited liability, meaning their potential losses are typically capped at their investment amount.
General Partner (GP)
They are the fund managers. They are responsible for setting the fund’s strategic direction and overseeing its day-to-day operations, including sourcing deals, conducting due diligence, managing the portfolio, and ultimately exiting investments. The GPs have unlimited liability.
The relationship between LPs and the GPs is governed by a detailed Limited Partnership Agreement (LPA), which defines the investment strategy of the firm, the fee structure, and other important terms.
Besides the GPs and the LPs, there are several other players in a private debt fund who also play an important role. These include analysts and specialists who provide crucial support to the fund managers in evaluating and managing investments.
How private debt funds work
The investment process of a private debt fund involves the following steps.
Identifying investment opportunities
The first step in a private debt fund’s operation is sourcing deals, i.e., seeking potential entities needing private debt financing. This typically involves leveraging established relationships and networks with intermediaries such as investment banks, private equity funds, financial advisers, and business owners. In some cases, corporate borrowers may bring potential debt financing opportunities directly to the private debt fund.
Initial deal screening
Once a deal is identified, it undergoes initial screening to determine whether it fits the fund’s strategy and risk profile. At this stage, the investment team assesses the loan amount, purpose, borrower type, and broad financial metrics. Deals that don’t meet the basic criteria are quickly filtered out to focus resources on stronger candidates.
This is one of the most critical steps in the process. The fund conducts a detailed evaluation of the borrower’s financial health, business model, and industry position. Key metrics such as cash flow stability, leverage, and collateral coverage are analyzed to understand the risk of default and the potential return.
This phase may also include scenario testing to assess how the borrower would perform under various stress conditions. The overarching goal here is to evaluate the risk-return tradeoff and determine whether the loan offers sufficient return relative to the risks involved.
Due diligence
If the borrower clears the credit assessment, the fund moves into due diligence. This involves validating the borrower’s financials, reviewing legal documentation, and evaluating any operational risks. The team may conduct site visits, consult external advisors, and review contracts or litigation history to ensure there are no hidden red flags.
Deal structuring
Once due diligence is complete, the next step is structuring the deal. This includes setting the interest rate, repayment schedule, financial covenants, and collateral requirements.
Investment committee approval
The proposed deal is then presented to the investment committee for final approval. The committee reviews the investment thesis, risk profile, and return expectations. If approved, the fund proceeds to legal execution and funding.
Execution and funding
Legal documents are finalized, and the capital is disbursed according to the agreed terms. The fund ensures the borrower complies with initial conditions and that all security interests are properly registered.
Ongoing monitoring
Post-investment, the fund closely monitors the borrower’s financial health and compliance with loan terms. This includes tracking timely interest payments, reviewing financial statements, and checking adherence to covenants. Missed or delayed interest payments can be an early signal of distress, prompting the fund to intervene or renegotiate terms. Active monitoring helps safeguard returns and ensures the portfolio remains on track.
These loan monitoring and administrative tasks are often referred to as middle office operations, and tend to be time-consuming, involved workflows that require in-depth knowledge of bespoke credit vehicles. Due to this, many private debt managers choose to outsource some or all of their middle office credit operations . Alter Domus offers services for any loan or fund operations task from such as loan agency or loan administration.
Key investment strategies for private debt funds
Private debt funds use several investment strategies to achieve their core objectives of generating consistent income, preserving capital, and delivering strong risk-adjusted returns for investors. Let’s break down the most notable strategies.
Sector-focused investing
Many private debt funds are increasingly adopting a sector-focused approach. Some sectors that are popular with private debt funds include real estate, technology, infrastructure, healthcare, and industrials. Focusing on specific sectors allows fund managers to build deep industry knowledge, build valuable networks, and better assess the risks and opportunities associated with potential borrowers.
Covenants and protections
Private debt funds often incorporate specific covenants in loan agreements. These covenants are designed to protect the lender’s investment and provide early warning signs if the borrower’s financial health begins to deteriorate. The two main types of covenants are:
Financial covenants: These, for example, may require borrowers to maintain certain leverage ratios or liquidity levels.
Operational covenants: These may include restrictions on asset sales, additional debt, or other business activities that could increase risk.
Diversification
Diversification is another key strategy that many funds use to achieve their objectives. Rather than concentrating capital in a few large positions, fund managers typically spread investments across multiple borrowers, industries, and geographies.
This approach limits the fund’s exposure to any single point of failure, be it a borrower default or regional economic shock.
Importantly, sector focus, which we looked at earlier, and diversification are not mutually exclusive. A fund may specialize in a few core sectors while still diversifying across different borrowers, deal sizes, geographies, and loan types. For example, a fund focused on infrastructure might diversify by investing in different sub-sectors (e.g., energy, transportation, and utilities) or by combining senior debt, subordinated debt, and unitranche structures.
The result of diversification is a more resilient portfolio; that is, one that’s better equipped to withstand cyclical shifts while delivering consistent, risk-adjusted returns over time.
Common questions about private debt funds
How liquid are private debt funds?
Unlike publicly traded stocks or bonds that can be bought and sold relatively easily on exchanges, private debt investments are generally considered illiquid. This means that it can be challenging for investors to sell their fund interests or the underlying debt holdings quickly and at a fair market price. In fact, most private debt funds are structured as closed-end funds with multi-year lock-up periods, typically ranging from five to ten years.
The illiquid nature of private debt is not inherently negative, however, as we’ve already seen. It’s often compensated by higher yields. But it does mean investors should carefully consider their own liquidity needs and investment horizon before committing capital.
Generally, private debt funds may be more suitable for investors with a long-term perspective, i.e., who do not require immediate access to their capital and are comfortable with it being committed for an extended period.
What are the fees and costs associated with private debt funds?
Like many other actively managed investment vehicles, private debt funds charge management and performance fees.
A typical structure includes a management fee of around 1% to 2% of committed capital, which covers operational and administrative costs. In addition, fund managers may earn a performance fee (or “carried interest”), of around 10% to 20% of profits, once a hurdle return is met, often in the range of 6% to 8%.
If there are any other fees or charges, they will be outlined in the fund’s LPA.
Final thoughts: Understanding private debt funds
Private debt funds have become a key part of the alternative investment space. Their appeal to investors stems from the potential for strong risk-adjusted returns, greater control over deal terms, and a low correlation to public market movements.
However, understanding the structure, operations, and strategies behind private debt funds is crucial for making informed investment decisions.
Overall, private debt can be a compelling option and a valuable addition to an investor’s portfolio, provided they are comfortable with longer investment horizons and limited liquidity.
For fund managers, success in the private debt market depends on not just being able to source quality deals but also having a strong operational backbone. Alter Domuscan help with the latter. We provide custom private debt solutions that streamline fund management, optimize operational efficiency, and support fund managers in navigating the complexities of the private credit markets.
Reach out today to learn more about how Alter Domus can support your private debt strategy.
Alter Domus is proud to sponsor the upcoming DealCatalyst CLO Annual Forum, taking place April 28–29 at the New York Marriott Marquis. Held in partnership with LSTA, this premier event is recognized as the leading gathering for the leveraged loan and CLO sectors.
Lora Peloquin and Tim Ruxton will be on site and ready to connect on how Alter Domus is helping shape the future of structured credit.
Alter Domus is excited to be attending the InvestOps Conference this March 10-12. Visit us at booth #83 to explore our innovative solutions designed to streamline investment operations and enhance your business efficiency. We look forward to connecting with industry professionals and discussing the future of investment operations. See you there!
Our team attending- Lizzie Heil, Stephanie Golden, Darrell Pisarra, and Devin Vasquez. See you there!
Lizzie Heil
North America
Managing Director, North America
Stephanie Golden
United States
Managing Director, Sales, North America
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EventsJuly 23, 2025
Rated Note Feeder Funds: A Route to Institutional Capital
We’re heading to Viva Las Vegas for Structured Finance Association SF Vegas conference. Tuesday, our Global Segment Head of Debt & Capital Markets Greg Myers will be speaking on the panel “The Future of Private Credit – Transparency, Regulation, and Valuation Challenges Impacting Institutional Investors 4:10-5:00 PM. We’re excited to be back at this premier networking event. Stop by our booth #62 to discover how we can help streamline your-back-office operations. Other attendees include David Traverso, Kennedy Glasscock, John Coviello, Pete Himes, Randall Reider, and Tim Ruxton.
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United States
Head of Sales & Relationship Management North America
Greg Myers
United States
Global Sector Head, Debt Capital Markets
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Rated Note Feeder Funds: A Route to Institutional Capital
The AD Score – An objective framework for optimal portfolio allocation
Optimal portfolio allocation in fixed income is a vital part of any investment decision, and it remains an important topic of discussion. This concept applies across all fixed income assets, including investment-grade debt, high-yield bonds, leveraged loans, structured credit, and private debt. To guide investors in their fixed income portfolio allocation decisions, Alter Domus has developed the AD Score – an objective framework that asset managers can use to optimize fixed income portfolio allocations.
Rudolph Bunja
Head of Portfolio Credit Risk
Portfolio optimization is a cornerstone of modern asset management, aiming to balance risk/return, promote portfolio diversification, and improve overall portfolio efficiency.
Fixed income managers actively seek to optimize their portfolio allocations such that the portfolio is expected to generate the maximum return with the least amount of risk. In this context, managers may apply an internal scoring methodology to grade assets as part of their investment decisions. These scoring methods in many cases rely on a weighted approach based on certain factors, many of which may be subjective. In addition, managers may rely significantly on a single guiding metric, such as yield, but still need to further control for other factors, such as credit risk, to be comparable.
Investment decisions are further complicated by various constraints. Constraints may be market driven, such as the availability of investments or market prices. Investor-mandated factors such as average credit quality, percentage limitations and duration may also come into play, as do regulatory factors, such as SEC, NAIC, Federal Reserve, Basel III rules.
These constraints can apply across all areas in fixed income, whether the asset is an investment grade credit, a high-yield bond, a broadly syndicated loan, private debt or structured credit. Constraints could also extend to other ‘cash flow intensive’ investments, such as commercial real estate and infrastructure.
Given the myriad factors that investors must consider, it comes as no surprise that portfolio optimization in fixed income is a sophisticated process with complex methods and techniques.
In this paper we present a framework designed to address these complex portfolio allocation challenges. This framework offers a single universal metric, the Alter Domus Score (‘ADS’), which can arm managers with a solution for efficiently measuring an optimal portfolio allocation that is objective and comparable across any fixed income investment.
The ADS, which is an asset-based measure, is also robust and controls for information relevant to any fixed income investment – including those tied to asset based loans – ranging from cashflow characteristics and credit worthiness to market price, pre-payment, and illiquidity costs.
We will detail the elements of the ADS, including the underlying framework, and illustrate the relationship between the ADS and changes to certain key asset-based characteristics.
Why Trade Optimization?
Trade optimization addresses a fundamental economic problem: maximizing the efficient and productive use of limited resources, specifically investable capital. Fixed income managers must, therefore, choose from among various investment opportunities to maximize the overall portfolio return given each investment’s attributes, which include cashflows, credit risk, and market price.
In most cases, managers are also faced with a variety of constraints, such as credit quality, maturity, and diversification limits, to name but a few, which adds more complexity to their decision-making process.
Essentially, managers aim to navigate these variables to deliver the best value for their investments.
The ADS presents a framework that relies on a single metric and objectively accounts for economic factors that are key to any fixed income investment. This framework is particularly valuable for managers bound by constraints, helping them to make the best investment allocations when weighing tradeoffs. The ADS serves as a complement and support to existing methods used by investment managers.
The ADS: an objective and universal measure for trade optimization
The ADS is an objective measure that is rooted in fixed income theory.
Essentially, it represents the discounted and risk-adjusted cashflows for any expected stream of cash flows, including fixed income instruments, such as bonds, loans, and asset-backed securities (ABS).
The ADS is easily comparable across all securities since it is a measure based on a single dollar (or any currency) value at risk. This feature allows any prospective universe of fixed income investments to be rank ordered on a pro-forma basis to determine an optimal portfolio allocation that is subject to constraints.
The score means that a fixed income investor can compare a bond to a loan or an ABS security – or even a real estate investment – when selecting the optimal portfolio allocation investment decision.
The score is agnostic as to the type of underlying investment and relies on the individual cashflow characteristics of the asset, factoring in the time value of the expected cash flow and uncertainties due primarily to the credit risk of the borrower and potential prepayments.
Digging into the detail: the formula behind the ADS
The ADS is calculated based on the following formula (see Appendix for detailed description of inputs).
To make effective comparisons across assets, the outstanding principal balance of the asset is first normalized to an indexed value of 1, which results in the market value (MV) to be a percentage of the indexed value. Therefore, we can break down the key inputs into two groups – one group is based on asset-specific attributes and the other reflects cashflow uncertainties.
To present it simply, the numerator represents the present value of the risk-adjusted weighted cashflows over the duration of the asset, the Cashflows Risk-Adjusted Value (C-RAV) while the denominator is the MV[1].
Some key factors to consider are that the risk related inputs can be based on the manager’s judgement or can be used to gather insight as to what the market value implies.
The ADS can also be used to generate trade ideas for making asset substitutions, when, for example, seeking a better relative-value opportunity, and thus can increase the likelihood that a portfolio will be better off or more optimal.
Applying the ADS in different scenarios
It is noteworthy to begin highlighting three possible scenarios of the ADS for any given security.
ADS > 1 (i.e., C-RAV > MV),
ADS < 1 (i.e., C-RAV < MV), and
ADS = 1 (i.e., C-RAV = MV).
Example 1: In cases where the ADS score is greater than 1, the time-value adjusted and risk-adjusted cashflows based on the manager’s expectations is greater than what the market price is reflecting. The asset is therefore ‘undervalued’, as indicated by the asset’s risk/return profile.
These are assets that offer the manager favorable investment characteristics, as the value of the risk-adjusted cash flows is greater than the price to acquire those cash flows.
Example 2: In cases where the ADS is less than 1, the time-value adjusted and risk-adjusted cashflows based on the manager’s expectations is less than what the market price is reflecting. The asset is thus ‘overvalued’, as indicated by the asset’s risk/return profile.
The manager will seek to sell these assets since the proceeds from those sales would exceed the manager’s fundamental assessment of what those cash flows are worth.
Example 3: In cases where the ADS score is equal to 1, the time-value adjusted and risk-adjusted cashflows based on the manager’s expectations is equal to what the market price is reflecting. So, the asset is ‘fairly valued’, as indicated by the asset’s risk/return profile. These assets have market values consistent with the manager’s fundamental assessment, and the manager would therefore be indifferent to holding, buying, or selling these assets.
When working through these scenarios, it becomes clear that a manager can begin to utilize the ADS as a metric for comparing and effectively rank-ordering decisions across different types of fixed income assets.
The ADS can also be used as a tool to inform the manager as to what the risk-based inputs the market is implying. With these inputs on hand, the manager can better assess whether an asset’s market price is rich or cheap.
Manager judgement, of course, is an important element to calculating the ADS.
The ADS could be pre-populated with apparently objective inputs and additional manager overlay could significantly improve the quality of the ADS and its utility as a tool to support portfolio optimization.
Assessment of prepayment rates and credit risk inputs are informed by asset manager expertise and play a big role in calculating the ADS.
Dissecting the AD-Score
The tables below illustrate the relationship between the ADS and changes to certain key inputs holding all else equal. We have intentionally kept the analysis simple so that we could better illustrate the mechanics behind the score.
A more thorough analysis, inclusive of actual cash flow payment dates (we assume annual for our simple analysis), spot risk-free rates (we assume a flat risk-free curve), more dynamic prepayment rates, and other more precise inputs are considered as part of the ADS.
For simplicity we also assume the assets are floating rate senior secured loans, but set at a fixed rate, and have a narrow band of possible recovery rates. The probabilities of default (PDs) are based on the Moody’s idealized default rate table.
The Tables that follow illustrate how the ADS score may shift under different scenarios:
Table 1: Impact of Coupon Rates and Credit Risk Ratings to the ADS
The first part of the analysis (see Table 1) shows the calculated ADS for a group of six stylized loans. The loan coupons range between 5.50%-10.75% (4.50% risk-free rate and risk premiums between 1.00%-6.25%) and have current ratings in the Ba2-Caa1 range. The loans have six-year stated maturities (with 10% constant prepayment rate – CAP) and assumed recovery rates of 45%. Note that for further simplicity we assume the current market values are 100% (or equal to par), and that the stated coupons are such that the current ADS is 1.00 (or ‘fairly valued’ at par).
Table 1 also shows a range of possible ADS scores based on changes to credit risk ratings and coupons. It can also be viewed as changes in the manager’s opinion of credit risk (or PD) associated with the loan. Furthermore, the ADS values can reflect the manager’s opinion on its own fundamental assessment of the loan cashflows (or C-RAV), holding all else constant.
In other words, these ADS values can reflect the manager’s opinion on what the fair value (or price) should be as a percent of par and can be used to compare to what the market price is offering.
Table 1: Impact of Coupon Rates and Credit Risk Ratings to the ADS
Initial noteworthy observations show that investors require compensation via higher coupons that are commensurate with lower rated loans, holding all else equal, such as a larger risk premium for riskier loans.
This can be reflected in the highlighted cells across the loans where the market price clears at par (also reflected with an ADS of 1.00). Notice that for each loan, a change to rating (or PD) impacts the ADS through C-RAV.
For example, if the stylized loan rated B2 were to be upgraded (or downgraded) by +/- 1 subcategory, the ADS value would change from 1.00 to 1.03 (and 0.96) respectively, assuming the market value of the loan remains pegged to 100%.
Table 2: Impact of Prepayment Rates to the ADS
Table 2 displays ADS values after reducing and increasing the CAP rate from 10% to 0% and 20%, respectively.
Table 2: Impact of Prepayment Rates to the ADS
This scenario, of increasing prepayment rates, effectively reduces the asset’s weighted average life expectation, thereby reducing overall coupon cashflows, while also reducing the exposed amount to default, or in other words, prepayments are not subject to loss.
We first notice that those loans with lower ratings (and higher coupons) appear to be the most sensitive to CAP. A lower CAP rate scenario seems to generate more than enough coupon cashflows to compensate for the longer period of exposure to default, such as relatively higher C-RAV and ADS.
In contrast, the higher CAP rate scenario appears to reduce the coupon cashflows enough to lower the ADS (and C-RAV).
Keep in mind that this is an isolated scenario analysis meant for comparison. The outcome can be sensitive to other variable inputs, such as the default timing profile.
Table 3: Impact of Maturity to the ADS
Table 3 displays ADS values after reducing the stated maturity of the loans from 6 years to 5 and 4 years, respectively.
Table 3: Impact of Maturity to the ADS
The stated maturity scenario analysis above shows that it has a similar effect to increasing the CAP rate (see Table 2) thereby drawing a similar conclusion.
Table 4: Impact of Recovery Rate to the ADS
Table 4 displays the sensitivity of ADS values at various recovery rates – from 40% to 50%.
Table 4: Impact of Recovery Rate to the ADS
This scenario analysis impacts the ADS through the loss given default (LGD) expectation of the asset. The table results are clear and intuitive in demonstrating that as recovery rates increase (or, as LGD decreases), the ADS naturally increases.
The extent of the increase appears to be in the range of 1-3 points of incremental ADS as recovery rates increase by 10% (from 40% to 50%). The larger ADS impacts are reserved for the lower-rated, or riskier, assets since the benefit of the higher recovery rates is most pronounced when the probability of default is relatively high.
A tool to navigate the complexities of fixed income portfolio allocation
Fixed income portfolio managers seek to optimize their portfolios to achieve the maximum return with the least amount of risk. However, they face numerous challenges, including market-constraints, investor/lender mandates, and potential regulation.
As managers strive to optimize their portfolios, they often utilize a scoring approach for generating trade ideas. In this paper we presented a framework that can support decision-making for these types of complex portfolio allocation challenges and complement frameworks that may already be in place.
The framework provides a universal score, the ADS, that is easily comparable across all cash-generating assets. The ADS is also simple, robust and controls for critical information, whether it is objective or subjective, relevant to any fixed income investment.
For AD clients, including clients of Solvas and Enterprise Credit & Risk Analytics, the ADS is offered as an additional measure to support our clients with their trade optimization, portfolio allocation, and risk analytics.
Please contact [email protected] for further information on how to access the ADS.
Appendix: Calculation of the Alter Domus Score
The first step to compute the Alter Domus Score (ADS) for any fixed income instrument is to normalize the initial face amount to a value of 1 in the relevant currency. The ADS is then calculated as follows:
Where:
[1]The MV can be adjusted in cases where the manager is subject to certain trading criteria. For example, CLOs commonly carry any loan that was purchased below a certain threshold (or ‘deep-discount’) at the purchase price, which results in a haircut to par in the OC tests. The ADS would effectively be capped (potentially at 1) in this instance.
Angela Summonte will be attending the BAI Private Debt Symposium 2025 in Frankfurt on February 6. Angela is looking forward to connecting with fellow industry leaders, innovators, and investors to connect and discuss the latest trends, opportunities, and challenges in private debt.
If you happen to be at the symposium, don’t miss the chance to connect with Angela in person!
Angela Summonte
Luxembourg
Group Director, Key Accounts
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EventsJuly 23, 2025
Rated Note Feeder Funds: A Route to Institutional Capital
Private debt is in line for a bumper year of deal flow in 2025 as M&A activity rebounds.
Greg Myers
Group Sector Head, Private Debt
Exploring private debt trends in 2025
Private debt is in line for a bumper year of deal flow in 2025 as M&A activity rebounds
Interest rate cuts will squeeze returns a little, but the asset class will continue to present compelling risk-adjusted investment opportunities
Private credit defaults are likely to track higher, but within manageable levels for managers equipped to troubleshoot
Competition for deals will intensify as broadly syndicated loan (BSL) markets continue to rally. Securities offered in this space are also predicted to evolve with trends, further enhancing attractiveness to investors.Debt funds must adapt pricing while leveraging securities to maintain competitiveness in core sectors.
Private debt’s so called “golden age” will still have room to run in 2025, even as interest rates come down and broadly syndicated loan (BSL) markets reopen. The financial landscape is evolving, bringing new views and strategies into private debt.
The asset class has proven resilience through rising inflation, benefiting from market shifts and proving reliable returns. With its floating rate structures benefitting from rising base rates at the same time as risk-averse BSL markets pulled up the shutters, opening the way for private debt managers to gain market share and take their pick from the best credits on offer.
These favorable dynamics have shifted in 2024, with central banks cutting rates as inflation subsided and BSL markets bouncing back to record double-digit gains in year-on-year issuance. Lenders will continue to provide diversified financing solutions to support various sectors.
Private debt managers will face increasing competition from global banking institutions and investors in 2025, impacting future financing. BSL markets in 2025 as a result, with BSL arrangers and investors showing strong appetite to lean back into M&A and leveraged buyout financings after a stepping back through the period of interest rate dislocation.
The last year has already seen BSL markets claim back market share, offering lower pricing to win back credits that were financed with private debt-backed unitranche loans.
Data from Bank of America and information from Bloomberg show that at least US$30 billion worth of private debt deals in the US were refinanced in the BSL market in 2024 at lower rates. BSL market participants will remain competitive, not solely based on pricing, but through strategic asset management. Arrangers, noting the speed of execution and certainty offered by private debt providers, have worked hard to get BSL pricing spot on to avoid flex and mitigate syndication risk.
For deep dives into key trends driving the 2025 private debt outlook, read on. Insights into how institutional investors view private debt’s role will be shared.
Pricing pressure for private debt investment targets
Banks and other financial institutions are reshaping their service profiles to adapt to these changes. Increased competition will keep private debt managers on their toes, but the asset class is still well placed for a strong year of activity and opportunity in 2025.
Managers will have to acknowledge the need to reduce margins to stay within a reasonable range of the pricing banks and BSL markets can offer in the year ahead. Many have already done so.
But while margins may have to come down, and interest rates are lower, private debt managers will still be able to deliver consistent, high single digit returns, as base rates remain well above levels from 24 months ago. On a risk-adjusted basis, private debt will continue to appeal to investors, even if returns are slightly lower than those delivered in 2024. Significant asset growth is anticipated across the private credit sector. Global trends indicate increased private market activities, including corporate financing.
Lower returns, however, will be more than made up for if a much-anticipated uptick in M&A activity is realized in 2025. Interest rate stability and the urgent requirement for private equity dealmakers to make distributions to LPs promises to deliver a meaningful uptick in deal volume and demand for private debt financing. With emerging corporate partnerships, private debt providers are poised to capitalize on substantial investment opportunities, also supported by significant asset allocations.
Private debt players have demonstrated the capability to finance significant credits during the period of interest rate rises. BSL markets may be open again, but private debt managers now have a track record of clubbing together to deliver financing for massive credits that not too long ago would have been the exclusive preserve of BSL markets. This showcases the increasing access to diverse private credit options that accommodate less traditional financing preferences.
Recently, for example, a club private credit managers teamed up to provide a £1.7 billion loan to help finance the take private of UK investment platform Hargreaves Lansdown. Private equity firms are exploring additional private market ventures, including direct lending strategies to leverage growth. While BSL markets will appeal to borrowers with lower pricing in 2025, but large credits will no longer default to BSL markets, as private debt managers show that they have the scale and appetite to offer flexibility and certainty of execution on big credits.
Dealing with private debt defaults
Strategic partnerships will be vital for managing private debt portfolios effectively, including asset risk considerations. A rise in deal financings, however, will not be the only thing taking up private debt manager time in 2025. Portfolio management will remain a key priority, as managers move to protect value and limit losses.
Private debt portfolios have proven resilient through a period of rising rates, and while defaults are expected to increase in 2025 as the impact of rising rates trickles down to borrower balance sheets, overall default levels should, all being well, remain within manageable thresholds.
Asset management strategies will need to adjust to address defaults. An uptick in defaults, however, will see a bifurcation in the market between managers with the capability and resources to steward credits through periods of stress and distress, and those that have strong transactional capabilities but haven’t made the investment in restructuring capability. This will become especially apparent in a market where defaults track higher at the same time as new financing deal volumes start to rally. Managers with lean teams will find it increasingly difficult to keep on top of new opportunities and keep troubled credits on track.
Regulatory changes influencing private debt
The evolving regulatory environment in 2025 is reshaping how companies value private debt. Emphasis on transparency ensures valuations precisely reflect the market conditions. This heightened scrutiny requires comprehensive and meticulous financial reporting.
Independent evaluations and transparent financial information will ensure asset values align with actual market conditions. Private credit managers must comprehend and strategize around regulatory shifts to manage obstacles. Emphasizing regulation can foster improved business practices among private credit managers, thereby offering clients more secure and stable investment options in a dynamic market landscape that features stringent regulatory standards from both global and regional authorities.
Leveraging global trends to expand in private credit
Banks are also participating more actively, providing complementary services to bolster private credit growth. Private credit is increasingly global, with heightened investor access to cross-border investment opportunities. The allure of high yields and diversification benefits is attracting global investors, making private credit a key strategy for asset managers aiming to harness international opportunities while managing financial risks. As global demand for securities evolves, embracing trends will be vital to stay competitive.
A good time to be in private debt
The next year might not be quite as good for private credit debt as 2023 and 2024, but the asset class is still set for a good 2025.
Winning deals will take more work as competition increases, and margins and returns will have to be adjusted accordingly for private debt to remain competitive in a market where other financing channels are beginning to function normally once again.
There will, however, be more deals to go for if M&A activity rebounds as expected, which should balance out the challenges posed by rising competition and tighter margins and returns.
The private debt “golden era” may have run its course, but private debt is an asset class that looks likely to retain is luster for some time yet.
Alter Domus cements connections across the Philippines and Asia with a new office in Manila.
Luxembourg and Manila, Philippines, December 12, 2024 – Alter Domus, a leading provider of tech-enabled fund administration, private debt, and corporate services for the alternative investment industry, today announced the opening of its new office located in Bonifacio Global City (BGC), Taguig, the Philippines. This strategic new location in Manila’s growing business hub underscores Alter Domus’s dedication to better serving its clients, improving access to its world-class fund administration services and facilitating collaboration with private markets firms.
The Manila office occupies a full floor of the state-of-the-art workplace located in the Ecoprime building in BGC. Over 100 employees are currently based in Manila, and Alter Domus aims to nearly double its workforce in the city by 2025. The firm is actively recruiting finance and accounting professionals to support this expansion. The office marks Alter Domus’ 39th global location and follows the launch of Alter Domus India earlier in 2024, expanding the organization’s footprint in the Asia Pacific region to 12 offices across seven jurisdictions.
I am thrilled to announce the opening of our vibrant Manila office and celebrate this milestone with our Alter Domus Philippines team. Establishing our presence in BGC enables us to better connect with our clients, strengthen our private markets services and technology and further expand our global reach.
Sandra Legrand, Regional Executive for Europe & Asia Pacific, Alter Domus
About Alter Domus
Alter Domus is a leading provider of tech-enabled fund administration, private debt, and corporate services for the alternative investment industry with more than 5,500 employees across 39 offices globally. Solely dedicated to alternatives, Alter Domus offers fund administration, corporate services, depositary services, capital administration, transfer pricing, domiciliation, management company services, loan administration, agency services, trade settlement and CLO manager services.
