Is Private Credit Performance a Fraud?

/ ChrisTobe

Private credit has become the darling asset class of pensions, endowments, insurers, and increasingly retail investors. It promises what every fiduciary wants to hear: near-equity returns, bond-like stability, and low correlation to markets. But as scrutiny increases—from PBS NewsHour, Bloomberg, academics, and regulators—the uncomfortable question is no longer whether private credit is risky.

It is whether the performance itself is real.

Start With the Basic Economic Reality of Credit Markets

Credit markets are among the most competitive markets in finance.

In real-world lending:

  • 10 basis points (0.10%) matters.
  • Borrowers arbitrage relentlessly between banks, public bonds, syndicated loans, and revolvers.
  • If a borrower can save 25–50 bps, they usually do.

This means true economic excess returns in credit are small unless you are:

  1. taking materially more risk,
  2. exploiting a temporary dislocation, or
  3. benefiting from non-price advantages that are not scalable.

There is no magic fourth option.

Now Add Private Credit Fees — This Is Where the Story Breaks

Private credit typically charges, conservatively:

  • ~100 bps management fee,
  • 10–20% performance fee (“carry”),
  • plus fund expenses, leverage costs, and transaction fees.

Let’s translate that into economics.

Example (simplified but realistic):

  • Gross loan yield: SOFR + 450 bps
  • SOFR: 5.0%
  • Gross yield: 9.5%

Subtract:

  • Management fee: –1.0%
  • Fund expenses & financing drag: –0.3%
  • Expected carry (annualized): –0.7%

➡️ Net to LP ≈ 7.5%

Now ask the obvious question:

If the same borrower can access public credit or bank credit at SOFR + 250–300 bps, why is private credit earning SOFR + 450?

Answer:
It usually isn’t—not without additional risk or accounting distortion.

Jeffrey Hooke and the “Mark-to-Myth” Problem

This is where the recent research by Jeffrey Hooke (Johns Hopkins), Xiaohua Hu, and Michael Imerman becomes pivotal.

In their Journal of Private Markets Investing article, the authors do something refreshingly simple:
They compare private credit funds to publicly traded ETFs with similar underlying assets, instead of the industry’s preferred, forgiving benchmarks.

Their findings are devastating:

  • Private credit funds barely outperform or underperform comparable public benchmarks.
  • Much of the reported “performance” comes from unrealized residual value—loans that have not been repaid and are not marked to market.
  • This is “mark-to-myth” accounting, eerily similar to illiquid public investments before the Global Financial Crisis

Why Private Credit is a Fraud

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As Hooke put it bluntly:

“Private credit performance is both lacking in alpha as well as a timely return of capital. The two main marketing points of the industry seem to be illusory.”

Why Private Credit is a Fraud

That is not activist rhetoric. That is an academic indictment.

The Five Ways Private Credit ‘Works’ — None Are Free

There are only five possible explanations for private credit’s reported success:

1. Illiquidity Premium (Overstated)

True illiquidity premia in credit are typically 25–75 bps, not 200–300 bps.
Yet private credit markets:

  • offer quarterly liquidity,
  • have active secondaries,
  • and show “smooth” NAVs.

That’s not illiquidity.
That’s delayed price discovery.

2. Covenant and Structural Risk

Private credit often:

  • lends to weaker borrowers,
  • accepts looser covenants,
  • uses PIK toggles and amend-and-extend,
  • relies on sponsor goodwill rather than enforceable protections.

This isn’t alpha.
It’s selling insurance against default and downgrade.

3. Regulatory Arbitrage

Private credit fills gaps where:

  • banks are constrained by capital rules,
  • borrowers fail public-market disclosure tests.

That’s not superior underwriting.
It’s regulatory arbitrage, and it disappears when losses arrive.

4. Valuation Smoothing (The Big One)

Private credit is not market-tested:

  • loans are marked by managers or friendly third parties,
  • downgrades are slow,
  • non-accrual is delayed,
  • restructurings avoid default recognition.

Result:

  • volatility is suppressed,
  • losses are deferred,
  • fees keep flowing.

Public credit shows pain early.
Private credit hides it.

5. Survivorship and Selection Bias

What you see:

  • successful funds,
  • cherry-picked vintages,
  • IRRs boosted by cash-flow timing.

What you don’t:

  • funds quietly wound down,
  • capital impairment absorbed years later.

Why Consultants and Pensions Love This Illusion

As discussed in my recent post on how pension consultants became the distribution arm for private equity, the same conflicts apply to private credit. Smoothed returns:

  • understate standard deviation,
  • understate correlation,
  • inflate Sharpe ratios,
  • and mechanically justify over-allocation.

The CFA Institute has explicitly warned that illiquid assets often exhibit stale and artificially smoothed returns, and that analysts “need to unsmooth the returns to get a more accurate representation of risk and return.”

Yet consultants rarely do.

Why This Matters for Pensions and ERISA Fiduciaries

For large plans:

  • Public credit costs <5 bps
  • Private credit costs 100–200+ bps all-in

The excess return hurdle must overcome:

  • fees,
  • illiquidity,
  • valuation opacity,
  • tail risk.

That is an extraordinary burden of proof—especially when borrowing spreads differ by tens of basis points, not hundreds.

Under ERISA principles, performance based on misleading valuation, smoothed risk, or delayed loss recognition raises serious questions about:

  • prudence,
  • reasonableness of fees,
  • and prohibited transactions.

This is not a theoretical concern.
It goes directly to whether reported performance is materially misleading.

So… Is Private Credit Performance a Fraud?

Fraud requires intent.
That is for regulators and courts to decide.

But systematic overstatement of returns, systematic understatement of risk, and performance driven by unrealized, unmarked residual value meet a lower—and more relevant—standard:

They mislead fiduciaries and beneficiaries about the true economics of the investment.

In a competitive credit market where 10 basis points matters, private credit cannot deliver persistent excess returns after 100-plus basis-point fees unless risk is being hidden, delayed, or transferred through opaque valuation and weak structures.

There is no third option.

Chris Tobe, CFA, CAIA has written extensively on Private Credit and its use in Public Pensions, and Life Insurance Portfolios backing annuities.  He was awarded the Private Debt Microcredential in 2023 by CAIA.  In his role as the Chief Investment Officer at Hackett Robertson Tobe in 2017 he completed a fiduciary review of the $4billion Private Credit Portfolio of the $40 billion Maryland State Retirement System.  His upcoming paper in the Journal of Economic issues looks at the Private Credit portfolios backing annuities.  

Related Reading

PBS Sounds the Alarm on Private Credit https://commonsense401kproject.com/2025/12/12/pbs-sounds-the-alarm-on-private-credit-a-warning-fiduciaries-and-regulators-can-no-longer-ignore/

Residual Risk: Benchmarking the Boom in Private Credit – Hooke et al  https://www.pm-research.com/content/iijpriveq/24/1/109

How America’s Largest Pension Consultants Became the Distribution Arm for Private Equity https://commonsense401kproject.com/2025/12/11/how-americas-largest-pension-consultants-became-the-distribution-arm-for-private-equity/

Private Debt as an ERISA Prohibited Transaction  https://commonsense401kproject.com/2025/07/18/private-debt-problematic-in-erisa-plans/

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