Moving beyond simplified narratives

Private credit is often framed as a single category. In practice, it encompasses a wide range of strategies, structures, and risk profiles. Senior secured lending, asset-backed financing, trade finance, and structured credit all respond differently to economic stress. The recent period of easy liquidity blurred these distinctions. Abundant capital compressed spreads and encouraged rapid deployment. In some cases, underwriting standards weakened as competition intensified. That phase is now giving way to a more discerning environment.

Yield is an outcome, and risk management is a process.

As refinancing risks rise and operating margins come under pressure, the differences between well-structured transactions and poorly structured ones are becoming more visible. This is not a failure of private credit as an asset class. It is a reminder that credit outcomes are shaped at origination.

Structure as the first line of defence

Structure sits at the core of private credit risk management. Unlike public markets, private credit allows investors to shape terms that directly influence downside protection. These include security packages, covenants, amortisation profiles, and priority of claims. In disciplined private credit strategies, structure is not treated as a checklist. It is a deliberate exercise in aligning incentives and mitigating foreseeable risks.

Security over cash flows or assets, conservative loan-to-value ratios, and enforceable covenants all serve to preserve capital when conditions deteriorate. Equally important is an understanding of how structures perform in practice, not just in documentation. Legal enforceability, jurisdictional considerations, and operational realities matter. Robust structuring reflects both financial analysis and practical execution insight.

The importance of selectivity

Not every borrower, asset, or opportunity is suitable for private credit, particularly in periods of economic adjustment. Disciplined selectivity begins with a clear definition of risk appetite. This includes sector exposure, borrower characteristics, and tolerance for leverage. The urgency of this discipline is underscored by the IMF’s latest findings, which reveal that approximately 40% of private credit borrowers are now operating with negative free cash flow in the current rate environment. It also requires the willingness to decline transactions that do not meet defined standards, regardless of yield.  In an environment where capital is no longer scarce, selectivity becomes a competitive advantage.

Investors who prioritise quality over volume are better positioned to navigate credit stress. This is especially true in markets where information asymmetry is high, and outcomes depend on detailed due diligence. Selectivity also extends to counterparties. Strong sponsors, transparent governance structures, and alignment of interests materially influence credit performance. Private credit, by its nature, relies on relationships. The quality of those relationships matters.

Governance as a risk mitigant

Governance is sometimes viewed as an overlay rather than a core investment consideration. In private credit, governance is central to risk control. Effective governance ensures consistency in underwriting, decision-making, and portfolio monitoring. It establishes clear accountability and reduces the influence of behavioural biases, particularly during periods of market pressure.

This includes independent investment committees, well-defined escalation processes, and regular portfolio reviews. It also encompasses conflict management, valuation discipline, and transparent reporting. These elements do not generate returns directly, but they protect against avoidable losses. Strong governance frameworks also support long-term credibility. For institutional capital, confidence in process is as important as confidence in performance.

ARM’s governance framework is designed to ensure:

• Independent risk oversight
• Consistent valuation practices
• Regular, transparent reporting
  

These elements are critical not only for compliance but for sustaining long-term investor confidence.

Managing risk across the life of the investment

Risk management in private credit does not end at deployment. Ongoing monitoring is essential, particularly in a changing macroeconomic environment. A January 2026 report from the Bank for International Settlements (BIS) highlights that as borrowers struggle under higher interest burdens, reliance on debt financing, particularly in high-growth sectors like AI, is ‘reshaping corporate balance sheets’ and testing traditional credit standards. This involves tracking borrower performance, covenant compliance, and external risk factors. Early identification of stress allows for proactive engagement, whether through restructuring, covenant resets, or additional protections. Active portfolio management also requires an understanding of correlation.

While private credit may offer diversification benefits, systemic shocks can still affect multiple exposures simultaneously. Scenario analysis and stress testing help investors assess portfolio resilience under adverse conditions. Importantly, disciplined managers distinguish between temporary dislocation and structural impairment. This distinction informs whether to provide support, restructure exposure, or exit a position.

Reframing return expectations

As private credit matures, return expectations must be grounded in risk-adjusted outcomes. The objective is not to maximize yield in isolation, but to generate durable returns with controlled downside risk. In the current environment, this may result in more modest headline returns than those achieved during periods of abundant liquidity.

However, these returns are often supported by stronger structures, better pricing discipline, and improved capital preservation. This reframing aligns private credit with its original institutional purpose. It is a tool for stable income generation, capital preservation, and diversification, not a substitute for speculative risk-taking.

Private credit in a disciplined portfolio

When integrated thoughtfully, private credit can play a valuable role in institutional portfolios. Its effectiveness depends on how it is selected, structured, and governed. The current market environment reinforces the importance of intentionality. Investors who approach private credit with discipline, patience, and rigorous analysis are better positioned to navigate volatility and capture opportunity.

Rethinking risk in private credit is not about retreating from the asset class. It is about returning to its fundamentals. Structure, selectivity, and governance are not constraints. They are the mechanisms through which private credit delivers its intended value.

ARM ALT-FUND views private credit not as a race for yield, but as a discipline of risk-aware capital deployment.