Does private equity inherently have more upside than private credit?
Betting with equity is sometimes an asymmetric bet. If you bet with $1, you can lose $1 or gain $20. There is more upside potential than downside. At worst you lose the $1, at best you can make $20+
If you bet $1 on loaning someone with 6% interest, at worst you lose $1, and at best you gain 6 cents ($1.06). The downside is much larger than your upside with credit.
What is it about private credit that would make it perform better or be more attractive than private equity?
What are the biggest flaws in this logic?
Your logic is 100% accurate in my view. The outcomes in credit are far more banded (low end would just be the interest/amort and any fees, upper end would tack on any interesting structures that add more upside (e.g., warrants or equity slug).
I'm sure I'll risk MS, but I see PC as lower risk, lower reward (you're first-out capital and risk of loss is much lower, so returns (and probably compensation) are commensurately lower). On the plus side, PC typically has better WLB as portfolio company management is simpler (unless investments become problematic or distressed) and sourcing/deal execution is easier given you're typically brought into processes that have higher likelihood of closing and diligence process is narrower (e.g., borrow sponsor's diligence work and 3rd party reports versus managing process yourself) (for new deals).
I feel like this is probably right, but how do you think about the combination of (i) lower pref hurdles for PC and (ii) potentially more AUM per investment professional?
Obviously on a deal by deal basis, PE would have way higher upside than PC, but I'm not sure to what extent that's offset by fund/cost structure.
Your two points hit the nail on the head. PC is a volume game. Lower risk, lower reward, but higher AUM per head and lower hurdles means comp is the same all else equal. Also, I wouldn’t be so sure about “way higher upside”, but naturally you’ll see dispersion with some donuts and some rocket ships.
By definition private equity has more upside. Unless there's significant equity exposure private credit isn't going to have any home run investment, however the often senior security results in lesser likelihood of a principal loss. Though the math isn't -$1 or +$20 - most average funds don't return much more than 2x. Private equity you have the benefit of controlling the company and associated value creation levers. The protection against the greater chance of a loss of principal is the uncapped upside.
Private credit has the unfortunate reality of being a commodity with not much differentiation between funds aside from mandate, cost of capital, and flexibility / ease of working with them if something goes wrong. Smart sponsors will run broad processes and there will typically always be pricing pressure, which further caps upside for "down the fairway" opportunities and often eliminates equity participation. PC funds will look to enhance returns by going deeper in the capital stack or finding opportunities that are less price competitive, though that strategy often just leads to self-selecting into riskier assets.
From a fund perspective, at least in the LMM, PC funds can have attractive returns by getting leverage at the fund level, which results in decent yields and returns for LPs. PC GPs can still do very well and the economics, carry, and lifestyle of PC can make it a very attractive seat. Unless you own the PC fund though, upside gets capped and there isn't as much of the operational skillset built as with PE that can translate into other high upside paths such as entrepreneurship.
Low risk lower reward for PC vs. PE but also significantly softer work life balance and stability.
The question of whether private equity inherently has more upside than private credit requires a nuanced analysis that goes beyond simplistic comparisons of return profiles. At the most fundamental level, PE's position in the capital structure as pure equity theoretically provides unlimited upside through both multiple expansion and EBITDA growth, while PC's returns are mathematically bound by contractual terms like coupon rates, call protection, and prepayment penalties.
However, this surface-level analysis misses crucial complexities that sophisticated investors must consider. In buyout scenarios, PE firms typically deploy capital through highly engineered capital structures, often utilizing 5-7x leverage through senior secured facilities, unitranche structures, or traditional senior/sub structures. we all know leverage amplifies both gains and losses - a successful deal generating a 3x gross MOIC might deliver a 20-25% IRR, while a struggling asset can quickly impair principal through negative deleveraging effects. Modern PE returns are increasingly driven by operational alpha rather than pure financial engineering, with value creation coming through strategic repositioning, bolt-on acquisitions, operational efficiency programs, and platform building. The private credit landscape has evolved dramatically, particularly in the upper middle market where competition has driven innovation in financing structures. Today's private credit deals often incorporate "equity-like" features such as PIK toggles, warrants, EBITDA ratchets, and incremental facility capacity that can generate meaningful upside beyond pure coupon income. Sophisticated private credit managers are increasingly moving into opportunistic credit, special situations, and structured capital solutions that blur the traditional lines between debt and equity returns. A well-structured unitranche facility with warrants and liberal EBITDA add-backs can generate equity-like returns in the mid-to-high teens while maintaining defensive positioning through liens and covenants. Portfolio construction dynamics also challenge the conventional wisdom. While individual PE deals may generate higher peak returns (the occasional 5x+ "home run"), portfolio-level returns for institutional PE investors are increasingly compressed by high purchase price multiples, abundant dry powder, and intense competition for quality assets. The median PE fund today struggles to clear a 2x MOIC hurdle. Meanwhile, private credit portfolios can generate consistent mid-teens gross returns through a combination of contractual income, call protection, upfront fees, and selective equity participation, all while maintaining downside protection through structural subordination and security packages. The role of expertise and operational capability is another critical factor.
Top-quartile PE firms consistently outperform through superior deal sourcing, operational improvement capabilities, and strategic vision - they're essentially building better businesses. This "operational alpha" potential is largely unavailable to private credit investors who primarily focus on downside protection through structural features and intensive monitoring. However, the best private credit managers can generate alpha through sophisticated structuring, pricing optimization, and selective participation in special situations or rescue financing scenarios where their structural protections provide negotiating leverage. Market cycles add another layer of complexity. PE traditionally outperforms in growth environments where multiple expansion and operational improvements drive returns. However, private credit can demonstrate remarkable resilience in downturns through structural protection and the ability to capitalize on market dislocations. During the COVID-19 crisis, for instance, many private credit portfolios proved more defensive than PE portfolios, while also maintaining the flexibility to deploy capital into attractive opportunities when traditional financing sources retreated. Contemporary private markets also demonstrate increasing convergence between PE and private credit strategies. PE firms are launching private credit vehicles, while private credit managers are building out stressed/distressed capabilities that capture equity-like upside in restructuring scenarios. So imo, contrary to popular belief, modern private credit strategies can actually generate superior risk-adjusted returns through innovative structuring. Consider a typical upper middle-market unitranche deal: L+550-600 pricing, 1-2% OID, meaningful call protection, 50-100bps of recurring fees, and well-structured EBITDA addbacks providing natural deleveraging. Layer in warrants or equity co-investment rights, and suddenly the "capped upside" argument begins to crumble. Top-tier private credit managers routinely generate mid-teens IRRs with significantly lower loss ratios than PE.
The conventional wisdom also fails to account for the profound impact of asset-level leverage on PE returns. A typical PE deal employing 6x leverage effectively transforms the investment into a deeply subordinated position with binary outcomes
This is great insight thank you. What are some significant trends driving private credit activity right now?
L+550? We still running on LIBOR?
Addbacks offer deleveraging? What?
Erm, you trade the upside for less risk? Pretty sure that's what debt investing is all about...
Mechanically speaking, private credit benefits from contractual priority and structural subordination: in a default, debt holders recover ahead of equity, often via collateral sale. Plus, floating-rate coupons tied to SOFR or LIBOR protect you in rising-rate cycles.
Equity returns, by contrast, hinge on IRR hurdles and carried interest, so your gains only materialize after value creation and exit multiples exceed your cost of capital. For more on these structural nuances and how they map to exemptions under Reg D and resale mechanics under Rule 144A, see https://www.jdsupra.com/legalnews/faqs-144a-resales-vs-regulation-d-3009433/
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