At a Glance
- Direct lending is often conflated with private credit but represents a distinct corner of the market.
It involves making loans directly to companies, frequently sponsor-backed by private equity, with equity support cushioning risk during times of stress. - Investors benefit from how direct lending is built.
Direct lending loans sit senior in the capital stack, are diversified across industries, and are typically floating-rate—offering resilience and yield advantages. - The opportunity set is far larger than public markets alone.
Because direct lending targets private companies—which vastly outnumber public firms—it provides investors access to a broader swath of the economy, which has allowed it to grow into a force in modern finance.
Private credit has quietly grown into one of the most important forces in modern finance, reshaping how companies borrow and how investors seek returns. And yet, much of the conversation around private credit still tends to blur definitions.
Part of the issue is this: “Private credit is a really large and diverse asset class,” said Jarrod Phillips, Ares Partner and Chief Financial Officer. “Often when you hear people say private credit, what they mean is direct lending.”
As Phillips explained, it is simple in concept: “Direct lending means that you are making a loan directly to a company.” Often, that company is what the industry calls sponsor-backed. “ That means that company is owned by a private equity fund,” said Phillips, “and the leverage at that company has at least some support in the form of the equity investment of that private equity fund.”
The value of that backing tends to show itself in moments of stress. “You see in times of large dislocations—like the COVID crisis—that the private equity firms will step in and provide additional liquidity to their investments to protect their investments and not allow the loans to default,” said Phillips.
Another defining feature of direct lending is its place in the capital structure: lenders sit above equity holders. “The nice thing about direct lending is that seniority in the capital stack,” Phillips said. “It’s also a way for them to be senior in the capital structure to equity.”
Diversification is a layer of protection. Instead of exposure to a single borrower, investors hold portfolios that span a wide range of sectors and companies. “When you’re invested, whether it’s a commingled fund or a retail product, you have a large diversification of the industries and the companies that you’re invested in,” Phillips said.
Direct lending differentiates itself in how its loans are structured—and in who can access them. “Unlike a lot of products that have historically been available to retail investors, these loans are floating-rate, meaning that as rates go up, your rates go up along with that, and as rates go down, they will float down,” Phillips explained.
That structure not only gives investors protection in a rising-rate environment, it often delivers more yield than comparable fixed-rate products. “Most often you are at a spread or a higher interest rate than you would be in some of those fixed-rate products,” he added. “So it’s a way for the average investor to get slightly more yield than they previously had access to.”
Direct lending also expands the playing field. “One of the important things to know about direct lending is it is not to public companies—it is to private companies,” Phillips said. “Here in the United States as well as globally, there are far more private companies than there are public companies. So you have access to far more companies than you otherwise would if you were investing publicly.”
That breadth has helped direct lending emerge from a specialized strategy to become a foundation of modern finance.
