Private credit has grown from a niche corner of the alternatives market into one of the most widely discussed asset classes in institutional and private wealth management – and Toby Watson’s perspective on the key questions it raises is informed by direct experience of how credit markets function across different economic environments.
The rapid expansion of private credit over the past decade has attracted significant investor interest – the combination of floating rate structures, illiquidity premia and direct lending relationships has made it an appealing addition to many portfolios. But the growth of the market has also introduced risks and complexities that deserve careful examination before capital is committed. Toby Watson, whose career in structured finance gave him a precise understanding of how credit markets behave across cycles, brings a well-grounded perspective to the questions that matter most.
Private credit – encompassing direct lending, mezzanine finance, distressed debt and a range of other non-bank lending strategies – has grown substantially as a proportion of the overall alternatives market over the past decade. The retreat of traditional banks from certain lending activities following the global financial crisis created space for non-bank lenders to expand. Toby Watson, whose time at Goldman Sachs involved working across structured credit markets and complex lending structures, developed a nuanced understanding of how private credit behaves across different parts of the economic cycle – and where the risks that are less visible in good times tend to surface when conditions change.
What Private Credit Actually Is and How It Works
Private credit refers to lending activity that takes place outside of public bond markets – typically directly between a lender and a borrower, without bank intermediation or public distribution. The key differences from public fixed income include lower liquidity, more intensive documentation, direct lender-borrower relationships and, typically, a yield premium compensating investors for those characteristics. Toby Watson considers understanding these structural differences essential before any allocation is made.
The growth of private credit reflects supply and demand factors. Regulatory changes following the global financial crisis caused traditional banks to pull back from certain lending activities, creating space for non-bank lenders. Simultaneously, the prolonged period of low-interest rates made the yield premium in private credit attractive to income-seeking investors. Toby Watson notes that both dynamics remain relevant, though the higher rate environment has changed the relative attractiveness calculation considerably.
Risk, Return and Due Diligence in Private Credit
Toby Watson identifies several risks deserving particular attention. Liquidity risk is the most obvious – private credit investments typically cannot be sold quickly at predictable prices. Credit risk can be more concentrated and harder to assess than in public markets. Valuation risk – the difficulty of marking illiquid loans to market – is a further consideration that affects how portfolio performance is reported and understood by investors.
The most underappreciated risk is the combination of valuation opacity and liquidity constraints in a deteriorating credit environment. When credit conditions tighten and default rates rise, the true quality of a private lending portfolio often becomes apparent considerably later than in a public market context – and the ability to exit positions is limited precisely when investors may most want to reduce exposure.
Credit quality assessment in private markets requires a different approach from public bond analysis. Without market pricing as a reference point, investors are more dependent on the manager’s own assessment of borrower quality and covenant compliance. Toby Watson’s structured finance background gives him a precise understanding of what rigorous credit analysis looks like – and what questions distinguish genuinely robust underwriting from more optimistic assumptions.
Toby Watson on Pricing, Structures and Market Dynamics
The shift to higher rates has had mixed effects. Most private credit instruments carry floating rate structures, meaning rising rates increase income from existing portfolios. On the other hand, higher rates increase the debt service burden on borrowers, which can stress credit quality – particularly for borrowers who took on significant leverage during the low-rate period. Toby Watson considers careful borrower-level debt service analysis essential in the current environment.
Structural protections matter considerably in private credit, where investors have limited ability to exit positions if credit quality deteriorates. Among the structural features that Toby Watson considers most important are:
- Covenant packages that provide early warning of borrower stress and give lenders practical leverage to address problems before they become losses
- Seniority in the capital structure, which determines repayment priority if a borrower encounters difficulties
- Appropriate loan-to-value ratios providing a meaningful cushion against asset value deterioration in secured lending situations
Private credit is best understood as a complement to public fixed income rather than a direct substitute. Its illiquidity premium is a genuine source of additional return, but it comes with constraints that affect portfolio flexibility. Toby Watson’s approach treats private credit as one component within a broader fixed income allocation – sized to reflect the investor’s genuine liquidity needs, rather than simply the attractiveness of the yield premium.
Manager selection is particularly important in private credit, where underwriting quality directly affects credit outcomes. Among the questions Toby Watson considers most relevant are:
- What is the manager’s track record across a full credit cycle, including periods of stress rather than just benign conditions
- How does the manager’s team handle borrower distress, and what resources do they have for workout situations
- Whether the manager’s incentive structure genuinely aligns their interests with those of investors, particularly regarding performance fee crystallisation and problem loan handling
