Diversification as a strategic imperative in European private credit

By Felix Janssen, Partner at LGT Capital Partners

Private credit has moved from a niche allocation to a structural component of institutional portfolios. In today’s environment, characterized by persistent macroeconomic uncertainty, geopolitical fragmentation and rapidly shifting capital flows, diversification within private credit has become not only a risk management tool but a strategic necessity. For Nordic investors in particular, whose portfolios often emphasize stability, long-term capital preservation and disciplined underwriting, the case for a diversified approach to European private credit is increasingly compelling.

While private credit has historically benefited from its illiquidity premium and insulation from public market volatility, the asset class is not immune to structural change. Cycles, regulations and borrower behavior evolve and so must portfolio construction. A multidimensional diversification framework across geographies, sectors, company sizes and transaction types is essential to building resilience and capturing relative value over time.

Europe versus the US: a shifting relative value equation

Geographic diversification remains a foundational element of private credit investing. Using direct lending as a reference point, Europe currently offers an attractive relative value proposition compared to the United States. European direct lending transactions continue to exhibit wider spreads, stronger lender protections and lower observed default rates. Borrowers in Europe typically operate with more conservative leverage profiles and are subject to underwriting standards that emphasize downside protection and covenant discipline.

By contrast, the US private credit market, while larger and more liquid, is navigating tighter financial conditions and elevated default expectations. Higher leverage levels and more borrower-friendly documentation have become more prevalent in recent years, particularly in competitive segments of the market. These dynamics do not diminish the strategic importance of US exposure, but they reinforce the value of maintaining flexibility across regions and allocating capital where risk-adjusted returns are most compelling at any given point in the cycle.

Staying active in both Europe and the US allows investors to adjust allocations as relative value shifts, while mitigating local risks linked to regulation, economic policy and market structure. For investors managing globally diversified portfolios, this flexibility is particularly valuable in navigating late-cycle dynamics.

Adapting portfolios to a new geopolitical reality

Sector diversification has taken on renewed importance as the global economy adjusts to a more fragmented geopolitical landscape. Deglobalization trends, rising protectionism and supply chain reconfiguration are reshaping risk profiles across industries. Certain sectors that were once considered stable now face structural headwinds that directly impact credit performance.

Capital goods and manufacturing businesses, for example, are increasingly exposed to tariff risks, input cost volatility and supply chain disruptions. These pressures can compress margins and challenge cash flow stability, particularly for companies with global exposure. At the same time, sectors such as software and business services, long viewed as defensive, are undergoing rapid transformation driven by advances in artificial intelligence. While AI presents significant opportunities for efficiency gains and growth, it also introduces competitive pressures that may alter business models, pricing power and long-term positioning.

A well-diversified sector allocation helps insulate portfolios from concentrated risks and allows investors to reallocate capital toward areas where innovation and structural growth support credit fundamentals. For private credit managers, deep sector expertise and ongoing monitoring are critical to distinguishing between disruption risk and durable value creation.

Size matters: resilience across borrower segments

Diversification by company size adds another important layer of portfolio resilience. Large-cap borrowers are often perceived as more stable due to scale, diversified revenue streams and access to multiple sources of capital. However, in an environment marked by regionalization and reduced cross-border activity, smaller and mid-sized businesses can offer compelling defensive characteristics.

National and local service providers tend to be more embedded in domestic economies and less exposed to global trade dynamics. In many cases, they benefit from stable demand and long-standing customer relationships. These attributes can translate into stronger downside protection during periods of macroeconomic stress.

Smaller businesses also represent a particularly attractive segment for private credit, as traditional banks continue to retreat from bespoke lending solutions. This creates opportunities for lenders to structure transactions with robust covenants, attractive pricing and meaningful influence over terms. For investors, exposure across size segments enhances diversification while supporting local economic activity.

An evolving opportunity set within private credit

Beyond traditional direct lending, flexibility across transaction types and sub-strategies has become increasingly important. Capital flows within private markets are shifting and investors who can dynamically allocate across the private credit spectrum are better positioned to enhance returns and manage risk.

NAV lending and GP financing are gaining prominence as private equity holding periods extend and fund-level financing needs grow. These structures provide liquidity solutions while offering lenders access to diversified pools of underlying assets. At the same time, credit secondaries are emerging as a valuable tool for portfolio rebalancing and liquidity management, particularly during periods of market dislocation.

Credit secondaries offer several attractive features in the current environment. Exposure to older vintages provides greater visibility into portfolio performance, while shorter durations and repricing mechanisms can enhance downside protection. For investors seeking to build or adjust private credit exposure efficiently, secondaries can accelerate portfolio construction and complement existing allocations.

The ability to pivot across these sub-strategies as market conditions evolve is a defining advantage for experienced private credit managers. Flexibility, combined with disciplined execution, allows portfolios to adapt to changing opportunity sets without compromising risk standards.

Fundamentals remain the anchor

Amid evolving market dynamics, the importance of rigorous underwriting cannot be overstated. Strong credit analysis, focused on borrower quality, cash flow resilience and covenant protection, remains the cornerstone of successful private credit investing. Familiarity with sectors, business models and sponsor behavior further enhances risk management and decision-making.

While robust fundamentals do not eliminate risk, they provide a framework for navigating complexity with discipline and confidence. For long-term institutional investors with a strong focus on stewardship and capital preservation, this emphasis on fundamentals aligns naturally with portfolio objectives.

Looking ahead

The private credit market continues to offer attractive opportunities, but success increasingly depends on a sophisticated and actively managed approach. Geographic, sector and size diversification must be implemented thoughtfully, while flexibility across transaction types enables investors to respond to shifting capital needs and market dislocations.

As uncertainty persists, those who embrace a multidimensional diversification strategy and maintain a firm commitment to credit fundamentals will be best positioned to build resilient portfolios and deliver consistent outcomes over time. For Nordic investors, European private credit remains a compelling component of this broader strategy. Against this backdrop, when pursuing the investment opportunity, non EUR Nordic investors should select partners which are well versed in mitigating currency volatility risk in their investment structures.