Head-to-head: Direct lending vs. high-yield credit — what’s the difference?

Direct lending has emerged as a crucial funding channel for mid-market companies, and has seen significant growth over the past 10 years, primarily due to a search for yield by lenders and investors. In some investors’ minds, it may have usurped the position of high-yield; we ask, are there good grounds for that?

Some investors may think that direct lending and high-yield credit are very similar, but it’s not the case. Put simply, direct lending involves making privately negotiated loans to companies — typically, outside the traditional banking system — with an emphasis on income stability and capital preservation. In contrast, high-yield or opportunistic credit strategies invest in publicly traded, sub-investment-grade bonds and loans, seeking higher returns through market-driven pricing, credit dislocations, and active risk management.

More specifically, direct lending is a subset of private credit in which asset managers originate or participate in bespoke loans, usually secured and senior in the capital structure. These investments are generally held to maturity, generate predictable floating-rate income, and offer downside protection through loan covenants and collateral. Because these loans are not traded on public markets, they are illiquid and valued infrequently — but also less exposed to short-term volatility.

On the other hand, high-yield and opportunistic credit strategies are actively managed portfolios of listed corporate bonds, loans, and sometimes distressed or ‘special situation’ securities. These strategies operate in public markets, using dynamic allocation across credit ratings, sectors, and geographies to capture excess spread. While they offer daily liquidity and broader diversification, they are more sensitive to interest rates, credit spreads, and market sentiment — resulting in higher return variability.

Direct lending requires origination capability, intensive credit due-diligence, and relationship-based access to borrowers. Opportunistic credit requires macro insight, trading agility, and robust risk controls. Both have important roles in modern portfolios — but understanding their structural and behavioural differences is critical when balancing income objectives, liquidity needs, and risk tolerance.

Head-to-Head

Below are two managed funds that have been randomly selected to go head-to-head in a comparison of their styles and approach. Note that their suitability for portfolios has not been considered.

Investment Approach

• Metrics Direct Lending Fund: This fund employs a private credit strategy centred on direct, bilateral lending to Australian corporate borrowers. Managed by Metrics Credit Partners, the fund takes a conservative, income-oriented approach by originating or participating in senior secured, floating-rate loans that are typically not accessible via public markets. The investment process combines rigorous fundamental credit analysis, active borrower engagement, and conservative structuring with covenants and collateral to mitigate downside risk. The fund is illiquid relative to traditional credit strategies, with redemptions offered on a periodic basis, and is marked-to-model rather than marked-to-market. The objective is to deliver stable, low-volatility income with strong capital preservation characteristics, without seeking tactical exposure to broader credit market movements.
• Bentham Global Income Fund: This fund adopts a multi-sector, opportunistic credit strategy investing across global high yield bonds, syndicated loans, investment-grade credit, collateralised loan obligations (CLOs), and emerging market debt. Managed by Bentham Asset Management, the fund is highly diversified across geographies, sectors, and credit structures, and it dynamically adjusts exposures based on relative value. Unlike direct lending, Bentham’s approach relies on public markets and actively trades around credit cycles to enhance returns. The strategy targets a net return of 4 per cent–6 per cent p.a., with daily liquidity and greater mark-to-market volatility. It’s particularly suited for tactical credit exposure within diversified, liquid portfolios.

Performance

Metrics outperformed Bentham and the RBA Cash Rate +3.25 per cent benchmark over one and three years, returning 8.5 per cent and 8.6 per cent respectively. Over the shorter term (one, three and six months) Bentham has been the strongest performer.

Risk Metrics

Over the past three years, the Metrics Direct Income Fund has reported exceptionally low volatility (0.42 per cent) and no observable drawdown, compared to the Bentham Global Income Fund, which recorded higher volatility (6.28 per cent) and a maximum drawdown of 3.96 per cent. While these figures highlight the perceived stability of private credit strategies, they do not tell the full story. Metrics’ returns are marked infrequently and based on internal valuations, rather than market pricing, which significantly smooths reported performance.

Additionally, private lenders like Metrics are often able to restructure or extend non-performing loans, which can defer the realisation of losses and further suppress drawdowns. In contrast, Bentham’s public market exposures are marked-to-market daily, capturing volatility and credit repricing in real time. This makes volatility and drawdown statistics more reflective of true market risk in the public credit space, but also more sensitive to short-term sentiment.

Transparency, Liquidity and Risk Recognition

The core distinction between public and private credit lies in valuation transparency and liquidity. Public credit funds, like Bentham Global Income, invest in listed bonds and syndicated loans that are priced daily based on market data. This results in greater visibility of volatility, mark-to-market drawdowns, and market beta, especially during periods of credit stress. In contrast, private credit strategies — such as Metrics Direct Income Fund — are based on directly originated loans that are valued infrequently using internal models, and are often held to maturity. This smooths reported returns and can significantly understate true underlying volatility and credit-event risk.

Ultimately, private credit offers benefits such as illiquidity premiums, covenant protections, and portfolio diversification, but comes with trade-offs — opaque pricing, reduced liquidity, and timing delays in risk recognition. Public credit, while more exposed to sentiment and spread volatility, is more liquid, transparent, and responsive. Both play important but distinct roles in portfolio construction: private credit as a stable income anchor for long-term investors, and public credit as a liquid, tactical tool with pricing efficiency and higher responsiveness to macro-economic shifts.