Private credit offers up to 22% returns: Why the advertised gains may not be what you get

Private credit involves loans extended by non-bank financial institutions and other private lenders. The asset class has expanded at a double-digit pace over the past five years, with industry estimates putting assets under management at around $25-30 billion. It has also become increasingly common in wealth-management portfolios.

Data from EY India shows that 166 private credit transactions worth $12.4 billion were completed in calendar 2025, representing a 35% increase from 2024. Real estate was the largest segment, accounting for nearly 42% of private credit transactions. Healthcare and industrials each represented about 15%.

The growth has been driven partly by relatively less attractive expected equity returns compared with the potential for private credit to generate returns of up to 22%. But there is also a structural reason.

Following the 2008 global financial crisis, the Reserve Bank of India tightened lending norms for banks and NBFCs. Lending standards became even more stringent following the Covid-19 pandemic. This created a financing gap for businesses that did not fit traditional lending criteria but needed capital quickly, flexible repayment structures, alternative collateral or customised financing.

Private credit stepped into this gap. However, the greater flexibility and potentially higher returns also mean investors take on additional risk.

Debt investment, but with significantly more risk

Private credit remains a debt investment, but it carries considerably more risk than conventional fixed-income products. It should therefore not be viewed as a replacement for the low-risk portion of an investor’s debt portfolio.

Its attraction lies in its ability to tailor financing arrangements to the requirements of borrowers while offering investors the possibility of enhanced returns for taking on additional risk.

Traditional lending is subject to detailed regulatory requirements prescribed by the RBI. Private credit, by contrast, operates within a framework that relies more heavily on disclosures, transparency, investor awareness and informed decision-making. The relatively lighter regulatory oversight means investors must conduct much more extensive due diligence themselves.

Before committing money, investors should examine the fund’s underwriting approach, historical performance and borrower profile. They should also understand the strength of loan covenants, the nature and quality of collateral, and the fund’s lock-in period. Private credit investments commonly have lock-ins of five to seven years, although the minimum commitment can be around three years.

Collateral can include unlisted shares, promoter holdings and other assets, making it important to assess how readily these securities could be realised if a borrower defaults.

An advertised return may not be the actual return

A private credit fund advertising an 18% return does not necessarily mean the investor will receive an 18% net return. Management fees, other expenses and taxes can materially reduce the final outcome.

Where returns primarily comprise interest income, taxation can have a significant impact. For an investor in the 30% tax bracket, an 18% interest return could effectively fall to 12.6% before accounting for surcharge and cess.

There are other factors to consider. Repayment delays, defaults, periods when capital remains uninvested and the time required to recover money can all reduce the effective return.

Higher risk demands higher compensation

Equity investors potentially receive the highest returns because they own a stake in the underlying business. But equity holders are also last in the queue when a company fails, making the investment high-risk while leaving the potential upside uncapped.

Private credit investors also assume meaningful risk, but their returns are generally capped at the agreed interest and other contractual payments. Another concern is liquidity. Private loans do not trade every day like listed securities, meaning the reported net asset value may not always capture the true value of an underlying loan.

Consider a fund that lends ₹1 crore, with both principal and interest payable at maturity. As long as the borrower continues servicing the loan, it may remain classified as performing. At a 9% interest rate, for instance, the borrower could pay ₹9 lakh annually while the underlying principal remains outstanding. The true financial stress may become apparent only when the principal falls due.

Key questions investors should ask

Investors should first understand the borrowers and determine why they chose private credit instead of approaching a bank or NBFC. The fund manager’s experience, investment track record and personal financial commitment to the fund are equally important.

Other questions include the number and type of loans in the portfolio, the quality of underwriting, the protection available against defaults and the performance of previous funds managed by the firm.

Fees deserve close scrutiny too. Investors should identify both disclosed and less obvious charges and determine whether the fee structure materially affects returns.

Potential conflicts of interest should also be examined, particularly where financial advisers recommend funds operated by related or affiliate entities.