Over the past 15 years, middle market direct lending has grown into one of the most dynamic areas of alternative investing. This part of the private credit market attracts institutions seeking income, diversification and resilience, but there are important differences within the asset class that Australian institutional investors should consider.
The success of private lenders in attracting capital has encouraged them to move “up market”, lending to larger companies so they can deploy capital more rapidly. Much of today’s private credit activity is concentrated in the upper middle market, where companies generate between $USD50 million and $USD100 million in earnings before interest, taxes, depreciation, and amortisation (EBITDA). Private credit is even available to large-cap borrowers that once relied primarily on public markets.
With private lenders moving into the upper middle market, competition has intensified: direct lenders are competing not just with each other, but also with syndicated loan and bond markets. Tight public market spreads have forced private lenders to match pricing and loosen terms, offering higher leverage and covenant-lite structures.
This competitive dynamic raises questions about whether these upper segments can continue delivering the same performance and diversification benefits that originally made middle market lending attractive.
Opportunities in the lower and core middle markets
At Principal Asset Management, we see more compelling value in the lower and core middle markets, where competition is more limited. Companies in the lower middle market generate from $USD5 million to $USD15 million in EBITDA, while core middle market companies generate $USD15 million to $USD50 million.
These markets offer a combination of structural protections and enhanced yields that are difficult to replicate elsewhere. Leverage levels are generally lower, and transactions include meaningful financial covenants - critical tools that enable lenders to act early if performance issues arise. Strong covenant structures and lower leverage have consistently been key drivers of credit performance over time.
The lower and core middle markets often provide more attractive spreads and yields compared to upper market deals. Investors may also benefit from original issue discounts and stronger call protection, improving overall return potential. These enhanced terms reflect the more proprietary nature and smaller scale of deals in this part of the market, characteristics that experienced lenders can effectively navigate.
Why U.S. private credit appeals to Australian institutional investors
For Australian institutional investors, U.S. private credit, particularly in the lower and core middle markets, offers both geographic diversification and currency advantages. The U.S. remains the world’s deepest and most developed private credit market, with a broad universe of borrowers and a mature lending infrastructure. Exposure to this market can help Australian portfolios balance domestic risk factors and tap into a larger pool of opportunities.
Many lower and core middle market borrowers in the U.S. operate in service-oriented industries such as healthcare, software & technology, and commercial, professional and consumer services that underpin the broader economy. These companies often exhibit strong growth, offering institutional investors exposure to a dynamic and expanding segment of the economy.
Additionally, the higher base rate environment in the U.S. continues to support income generation for floating-rate private credit strategies, even as global markets adjust to shifting interest rate expectations.
As private credit continues to evolve, not all parts of the market offer equal value. For Australian wholesale clients, such as super funds, family offices, and high-net-worth investors seeking consistent income and capital preservation, U.S. lower and core middle market private credit provides a compelling alternative to traditional fixed income.
Learn more about Principal Asset Management’s private credit offerings here.
