Private credit: The Red Thread – Alternatives

1Q26 performance

In the first quarter of 2026, the corporate direct lending market exhibited a softening in performance. At a high level, most corporate direct lending funds were flat in 1Q26. Interest income was the key positive driver of performance, as the 1Q26 distribution rates were essentially unchanged compared to the 4Q25 distribution levels.

However, the positive carry was offset by mark-downs on the underlying loan portfolios. The vast majority of losses were unrealized, as the downward shift in valuations was driven by a combination of widening syndicated loan spreads, uncertainty related to artificial intelligence (AI) disintermediation, and increased geopolitical tensions in the Middle East. Managers with larger exposures to either software loans or syndicated loans tended to underperform compared to peers. Private credit vehicles, especially those structured as business development companies (BDCs), tend to have an allocation to public syndicated loans of 10%–20% on average.

Fundamentals

Although there was some modest downward pressure on valuations, the fundamental performance for the corporate direct lenders on the UBS platform was generally stable. In terms of operating performance, the vast majority of the companies have demonstrated positive EBITDA growth and stable margins. As it pertains to credit metrics, non-accrual rates remained low and did not change quarter-over-quarter. Larger companies have generally exhibited lower default rates compared to smaller businesses in the current period. In addition, interest coverage ratios generally improved as a result of stable borrower earnings and a decline in base rates.

Conversely, payment-in-kind (PIK) interest has continued to trend higher. While this is a risk factor that we are monitoring closely, the majority of the PIK interest is attributable to deals that were structured as PIK at origination, as opposed to being part of a loan modification. As it pertains to AI disintermediation risk, the Unified Global Alternatives – Private Credit (UGA – PC) team has not observed a meaningful change in credit metrics during the current period.

Software default rates have remained low and the operating performance for most of the businesses remains strong. The base-case expectation for the software sector is that dispersion will be higher going forward and the sector will likely exhibit a higher default rate than it has historically. That said, we expect this dispersion to play out over the next two to three years.

Investor flows/redemptions

Despite a relatively stable fundamental backdrop, the corporate direct lending strategy has experienced a material increase in redemption requests. The non-traded BDC universe has been adversely impacted by persistent negative headlines for private credit, coupled with perceived risks related to AI and the impact that these could have on existing borrowers. At the industry level, the average non-traded BDC redemption request was 11.0% of NAV for 1Q26. The non-traded BDCs typically have a 5% quarterly limit for redemptions.

As a result, a number of BDCs have utilized their gating provisions given the elevated redemption activity. Overall, we believe the gating activity is appropriate and in line with expectations. While BDCs have faced higher redemptions across the industry during the first quarter, we have not observed a material change in the fundamental performance of the managers on the platform.

While we believe corporate direct lending should remain a core component within a private credit portfolio, investors should also consider diversifying into other segments of private credit, specifically asset-backed finance (ABF). ABF is a form of private lending where the loans are secured by income-generating assets. In addition to generating cash flow, ABF provides exposure to a wide and diversifying set of asset classes that are complementary to the corporate direct lending sub-strategy. The core components of the ABF universe are residential real estate debt, commercial real estate (CRE) debt, specialty finance, and structured credit. Certain ABF portfolios may also include investments in income-producing real assets.

Residential real estate debt

The residential real estate debt sub-strategy remains a consistent source of potential opportunity. UGA – PC believes residential real estate debt can deliver a consistent level of interest income. Valuations across most segments of the residential market are at their historical heights, as credit performance has been strong.

In terms of outlook, UGA – PC remains constructive on the opportunity set, although the residential real estate debt market is experiencing a mix of tailwinds and headwinds, particularly in the US. The overall level of mortgage rates is elevated compared to recent history, and the 30-year fixed-rate mortgage average in the US closed 1Q26 at 6.38%, which is +0.40% compared to the end of 2025. The current mortgage rate continues to have a meaningful impact on both housing turnover and affordability.

In terms of tailwinds, the US housing market has benefited from strong fundamentals for the existing homeowner cohort, which is generally characterized by low delinquency rates, low home price appreciation (HPA)-adjusted loan-to-values (LTVs), and below-market locked-in mortgage rates. However, these positive characteristics are partially offset by historically stretched affordability metrics, and the base case is that the US housing market will continue to exhibit higher dispersion by sub-market due to differing supply/demand dynamics.

As a result, UGA – PC is focused on residential real estate debt investments that are senior in the capital structure and that are not dependent on HPA. Homebuilder finance remains a core theme in portfolios, with a general preference for shorter duration and seasoned assets.

Commercial real estate debt

The CRE debt sub-strategy remains a core focus. From a fundamental perspective, the CRE lending market has stabilized relative to two years ago. While some legacy loans continue to face refinancing challenges, a meaningful portion of the universe has been able to refinance. From the UGA – PC perspective, the best opportunity set today exists in newly originated CRE bridge or construction loans.

For the current vintage, managers are able to lend at LTVs that reflect current values of CRE assets. In addition, these loans provide a high degree of current income. UGA – PC remains active in multifamily bridge lending, although spreads in this sector have tightened. In addition to performing lending strategies, UGA – PC remains constructive on opportunistic CRE debt strategies in the US and Europe.

Specifically, there is a large supply of legacy loans that were originated prior to the interest rate increases that are struggling to refinance given the current LTV or interest coverage profiles. This dynamic should provide managers with the opportunity to source higher-returning CRE debt investments through either discounted secondary loan purchases or capital-solutions-oriented new origination.

Specialty finance

The opportunity set for specialty finance remains diversified across a wide range of asset classes. As it pertains to the consumer and small business lending asset classes, UGA – PC remains active in these markets but focused on preferred investments. Overall, we remain cautious on this segment of the market given the prior stresses exhibited by the lower-income segments of the borrower universe.

That said, the delinquency and write-off rates observed for the underlying consumer and small business were fairly consistent through the first quarter of 2026. While consumer spending has been driven by the higher-earning cohort of the universe, we have not seen a material change in the credit performance of the broader borrower universe in the recent loan vintages.

In terms of incremental capital deployment, we see the best opportunities in short-duration lending strategies. In particular, we have favored investment opportunities where we can ‘move up the capital structure’ and lend to a pool of consumer or small business loans, as opposed to owning the assets outright. This strategy should provide portfolios with a consistent level of carry and higher downside protection via credit enhancement in the event of a recession or an increase in loss rates. In addition, we continue to evaluate other niche strategies outside of consumer and small business lending that can deliver a consistent level of returns that are less correlated with the larger segment of the private credit universe.

Structured credit

During 1Q26, the US leveraged loan market exhibited higher dispersion. The dispersion rose as the market became more concerned about the risk of AI disintermediation within the software sector, which is approximately 15% of the syndicated loan market. As a result of the decline in loan prices, the collateralized loan obligation (CLO) market was re-rated lower. There was a material amount of price declines within the CLO mezzanine debt and CLO equity segments of the market.

As a result, secondary CLO equity tranches now trade at higher yields. While this sector is exposed to software, we believe it provides a reasonable loss-adjusted yield for certain CLO equity tranches. As a result of the improved relative value, UGA – PC modestly increased its exposure to CLO equity during the quarter. Although we are waiting for a better entry point before increasing our exposure further from current levels, CLO equity offers a higher total return potential compared to most other segments of the credit market today. In addition to secondary CLO equity, UGA – PC also remains selectively active in CLO warehouses.

The private credit market continues to deliver a wide range of actionable investment opportunities. Overall, 1Q26 reflected a period of softer performance for corporate direct lending, with stable interest income offsetting unrealized valuation declines, which were largely due to the increase in syndicated loan market volatility.

Portfolio credit metrics remained resilient, with low non accruals, stable operating performance, and improved interest coverage supporting the asset class. While elevated redemption activity led to increased gating across non traded BDCs, this dynamic has not translated into meaningful fundamental stress among managers on the platform.

Looking ahead, we believe diversification within private credit, particularly into asset backed finance, offers attractive opportunities to enhance portfolio resilience across varying market environments.

Residential and commercial real estate debt, specialty finance, and structured credit each provide differentiated return drivers and attractive relative value today. Taken together, we believe private credit can be beneficial as part of a diversified portfolio, particularly for investors seeking consistent cash flow or those with defined distribution needs.

Private credit sector performance outlook