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Private debt investments have been gaining importance for years. They provide access to lending strategies outside public markets and enable companies to obtain financing beyond traditional bank loans. “This structure creates flexibility for both sides – but it also changes how risks arise and become visible,” says Thorsten Fischer, Managing Director and Head of Portfolio Management at Moventum AM.

Unlike publicly traded bonds, stress in the private debt market does not manifest through daily price movements or rapid outflows. “Illiquidity stabilises valuations in the short term, but it does not prevent losses,” Fischer explains. “It shifts the perception of risk, as problems emerge at the level of borrowers and fund structures and develop over weeks or months.” For investors, this changes the perspective on the portfolio structure itself: rising defaults and a growing share of distressed exposures act as key early indicators.

Private debt funds often finance mid-sized companies with higher levels of leverage. “These are sensitive to rising interest rates and economic slowdown,” says Fischer. “And at present we are in an extremely fragile environment, both in terms of interest rate developments and the global economy.” A careful assessment is therefore essential.

If payment difficulties arise, loans are restructured or maturities extended. At the same time, impairments become necessary, directly affecting fund performance. Another particular feature is valuation. Private loans are not continuously traded on the market but are valued using models. “If the environment deteriorates, valuation adjustments occur with a time lag,” Fischer notes. “Stress therefore becomes visible in declining net asset values, rising loss expectations and an increasing number of loans in watchlist or default categories.” Unlike daily liquid bonds, there are no abrupt price swings, but rather gradual corrections.

Another characteristic is the semi-liquid fund structure. These allow periodic redemptions, for example monthly or quarterly. “If redemption requests increase faster than new inflows, funds come under pressure,” says Fischer. “We have seen this in open-ended real estate funds in the past, where terms were subsequently adjusted.” Possible responses include redemption restrictions, asset sales or the build-up of liquidity buffers. Such measures can intensify tensions in the market.

The structure of the private debt market can make volatility appear smoothed. “Prices react less immediately, but risks do not disappear,” says Fischer. “They simply become visible more slowly.” Early indicators include breaches of contractual lending terms (so-called covenant breaches), more frequent loan extensions, write-downs and rising redemption requests. Against this backdrop, the risk of a gradual accumulation of poor-quality exposures increases. “In an economic downturn, a larger number of lower-quality loans can build up in portfolios,” Fischer explains. “However, the full extent only becomes visible as defaults rise and portfolios are adjusted.”

A further risk factor lies on the borrower side. Companies use private debt not only as an alternative, but in some cases as a substitute when regulatory constraints limit access to traditional bank lending. As a result, capital may flow into segments that would be subject to stricter scrutiny within the banking system. For investors, this means that private debt offers access to seemingly stable returns, but requires a more thorough and comprehensive assessment of risks. “These risks are less visible, but not lower,” Fischer concludes. “They are inherent in the structure itself – and can accumulate and materialise during a downturn.”