Key points
Ask most allocators whether their private credit book is diversified and they will point to the number of managers, or the number of funds. Look underneath and the picture often changes. The same sponsor-backed mid-market borrowers turn up in fund after fund, financed on similar terms, refinancing in the same years, and exposed to the same earnings and rate pressures.
Private credit was sold to many investors as a diversifier. It can be one. But the market has grown up around a narrow core, and by 2026 that core has started to show strain. Fitch's US private credit default rate reached 6.3% in August 2026, a new high, while managers of retail evergreen funds spent much of the year managing redemption queues.
This guide sets out where diversification in private credit actually comes from, how to test a portfolio for it, and what a better-built allocation looks like.
Why diversification in private credit is harder than it looks
Direct lending to mid-sized companies is now roughly a $1.5 to 2 trillion market, about the size of the broadly syndicated loan market, and is forecast to reach $3 trillion by 2028, according to Cleary Gottlieb. It became the anchor of most private credit allocations for good reasons: scale, established borrowers, private equity sponsors overseeing the business, and returns that compared well with public markets.
Familiarity then turned into habit. As capital poured in, similar deals were repeated across managers. Leverage drifted up, refinancing assumptions became routine, and portfolios that looked diversified by name were increasingly exposed to the same risks. Larger deals are now often split across many lenders. CreditSights reported that a single $4.6bn financing for Zendesk was held across 20 business development companies, with average portfolio overlap highest among the largest funds.
Post-crisis banking rules pushed credit creation out of banks and into private funds, and policymakers welcomed the result. That tolerance let the segment grow with little scrutiny of where risk was building, as long as defaults stayed low. We look at how that crowding happened, and what it means for family offices, in the mid-market allocation trap.
Diversification starts with borrower numbers
The simplest test of diversification is to count how many borrowers ultimately pay the investor. Many corporate credit strategies rely on a relatively small number of loans. Even large funds may hold only a few dozen credits, and a single default can move returns.
That structure produces a recognisable pattern. Performance is steady most of the time, then changes quickly when individual borrowers deteriorate. Defaults are infrequent but material, and recoveries depend on timing, negotiation and the state of refinancing markets.
Other parts of private credit are built differently. Invoice finance, trade finance, consumer credit and much SME lending are built on large pools of small exposures. Returns come from thousands of payment streams. Stress tends to show up gradually, in arrears data and collection trends, giving a lender time to act through tighter eligibility criteria or a lower advance rate. Our guide to receivables-based finance explains how those pools work.
Two portfolios can quote the same yield and behave completely differently when conditions turn. The one backed by many borrowers absorbs pressure; the one backed by a few concentrates it. We examine the single-name side of that equation in concentration risk in mid-market private credit.
Sector exposure changes how portfolios behave
Different lending sectors respond to different drivers:
- Corporate borrowers are sensitive to earnings, leverage and the refinancing market.
- Receivables and trade finance depend on turnover, payment behaviour and operational controls.
- Consumer and SME credit responds to employment, loan seasoning and the quality of servicing.
- Facilities to specialty lenders depend on the lender's underwriting, its collateral pool and the protections written into the facility.
Fitch's August data shows how unevenly stress falls. Defaults among healthcare providers and industrial borrowers ran at 9.9%, while technology software sat at 0.6%. Because these drivers differ, combining sectors reduces correlation in a way that adding more managers within one segment cannot.
| Strategy | Typical borrowers in a pool | Main return driver | How stress appears |
|---|---|---|---|
| Sponsor-backed direct lending | Tens of companies | Corporate earnings and refinancing | Suddenly, through covenant breaches or missed payments |
| Receivables and trade finance | Thousands of invoices | Payment behaviour and turnover | Gradually, in dilution and collection data |
| Consumer and SME loan pools | Thousands of loans | Employment and servicing quality | Gradually, in arrears and roll rates |
| Senior facilities to specialty lenders | One lender, backed by thousands of loans | Lender underwriting and collateral pool | In borrowing-base tests, before losses reach the facility |
The five tests of a diversified private credit portfolio
When we look at a private credit allocation, we ask five questions. Each one tests a different dimension of diversification.
- Borrower breadth: how many independent payers ultimately support the return?
- Return driver: do the exposures depend on different economic variables, or all on corporate earnings and rates?
- Seniority and security: where does the investor sit in the capital stack, and what collateral sits behind the loan?
- Structure: is the exposure to a defined, ring-fenced pool of assets, or to a manager's blended balance sheet?
- Origination channel and vintage: are the loans sourced through different channels and spread across years, or bought in one crowded market at one point in the cycle?
A portfolio that passes all five tests is diversified. One that only passes the first, by holding many managers that lend to the same kind of company, is not.
Why distribution trends raise the stakes
The push to open private credit to wealthier individuals has made these questions more pressing. Mid-market corporate lending is increasingly repackaged into evergreen funds and sold through platforms to high-net-worth and retail-adjacent investors, the group least able to absorb drawdowns or delayed liquidity.
The underlying assets have not changed. Borrower numbers have not grown and dependence on refinancing remains. What has changed is who holds the risk. In February 2026, Blue Owl ended redemptions in one of its retail funds, OBDC II, and agreed to sell $1.4bn of loans across three vehicles to institutional buyers. Wider distribution spreads ownership of the loans; the credit risk stays with the same borrowers.
Institutional investors have noticed. Rede Partners' 2026 market survey found 70% of LPs expect diversification beyond direct lending to be the leading trend over the next 12 months, with asset-based finance among the main beneficiaries, and only 6% planning to add to mid and upper mid-market direct lending. The reasons are set out in our look at the emerging risks of direct corporate lending.
What diversification looks like in practice
In practice, diversified private credit is built by combining sectors with different borrower profiles and cash-flow behaviour. That usually means smaller deal sizes and closer operational involvement. It also means paying attention to how assets are monitored, serviced and legally protected.
Structured transactions help, because they give investors exposure to defined pools of assets rather than to a manager's whole balance sheet. The structure decides how cash is controlled and what happens when performance weakens. Our investor's guide to asset-based lending covers the mechanics.
This is the approach we take at Kingsbury & Partners. We lend to lenders: senior secured facilities to non-bank and specialty lenders, often their first institutional credit line, secured on pools of underlying loans and held to maturity through bankruptcy-remote credit linked note compartments. Each facility rests on many small borrowers, and the protections are built into the documents from the start.
What this means for investors
Private credit can still deliver income and diversification, but it no longer does so by default. A portfolio built around one lending model, however many managers it uses, tends to behave as one portfolio under stress.
For family offices, wealth managers and private clients, the practical steps are clear. Count the borrowers, map the return drivers, check where you sit in the structure, and look for overlap between managers. Then size the allocation to genuine time horizons, because the illiquidity premium only pays those who can hold. The work is greater up front. The payoff is a portfolio that holds together when one part of the market does not.
Frequently Asked Questions
How do you diversify a private credit portfolio?
Combine strategies with different return drivers, such as corporate direct lending, receivables finance, consumer and SME loan pools and facilities to specialty lenders, and check borrower numbers, seniority, structure and vintage rather than only the number of managers.
Is private credit a good diversifier?
It can be, because returns are contractual and less tied to daily market sentiment. But a portfolio concentrated in sponsor-backed mid-market loans is exposed to the same earnings and refinancing risks across funds, which limits the benefit.
What is concentration risk in private credit?
It is the risk that a small number of borrowers, sectors or sponsors drive a large share of returns, so that a few defaults or one sector downturn hurt the whole portfolio.
What is asset-based finance in private credit?
Lending secured on pools of financial or physical assets, such as receivables, consumer loans or equipment, where repayment comes from the assets' cash flows rather than from a single company's earnings.
Does investing with several private credit managers improve diversification?
Only if the managers lend to different kinds of borrower. Large direct lending funds often hold the same loans, so overlap between managers should be checked before assuming diversification.