The Problem with Private Markets

Key Concepts

• Private Markets: Investments in assets not listed on public exchanges (Private Equity, Private Credit, Private Real Estate).
• Illiquidity: The inability to easily sell an asset for cash without a substantial loss or delay.
• Volatility Laundering: The practice of masking the true volatility of an asset by using infrequent, subjective valuations rather than daily market-based pricing.
• Gating: A mechanism used by fund managers to restrict or halt investor redemptions when liquidity is insufficient to meet demand.
• NAV (Net Asset Value): The reported value of a fund’s assets minus its liabilities; in private markets, this is often an estimate rather than a market-tested price.
• Continuation Funds: Vehicles used by private equity managers to buy assets from their own existing funds, often to provide liquidity to original investors.
• Evergreen Funds: Semi-liquid investment vehicles marketed to retail investors that provide fund managers with flexible capital.
• Adverse Selection: A situation where retail investors are sold assets that institutional investors or the broader market have rejected or deemed undesirable.

1. The State of Private Markets

Private markets are currently facing a significant liquidity crisis. Unlike public markets, where price discovery happens in real-time, private assets rely on infrequent valuations, creating an illusion of stability. Ben Felix argues that this "mystique" is being stripped away as funds are forced to gate redemptions, write down asset values, and struggle to exit positions.

2. Asset Class Breakdown

Private Equity (PE)

• Mechanism: PE firms acquire stakes in private companies (buyouts) or early-stage ventures (venture capital) using high leverage.
• The Fee Problem: While managers generate high returns before fees, net-of-fee returns are often comparable to public market equivalents. Fees can reach ~6% annually.
• Current Issues: Managers are struggling to exit investments at the traditional 3–7 year cadence. This has led to the rise of Continuation Funds, where managers sell assets to themselves, raising concerns about valuation accuracy and "buying lemons."
• NAV Squeezing: Universities (e.g., Harvard, Yale) have sold PE stakes at ~11% discounts to NAV. Secondary buyers then mark these assets back up to the original NAV, creating "paper" returns that do not reflect underlying economic improvements.

Private Credit

• Mechanism: Non-bank entities provide loans to private companies.
• Risk Profile: These loans are inherently risky and often mirror the characteristics of high-yield bonds or volatile stocks.
• The "Closed Loop" Risk: Private equity firms are increasingly buying insurance companies and stuffing their portfolios with private credit, creating a systemic risk loop where the same firm manages the lender, the borrower, and the insurer.

Private Real Estate

• Mechanism: Direct ownership of physical properties (office towers, malls).
• Market Reality: When private real estate funds attempt to go public to provide liquidity, they often suffer massive drawdowns. Felix cites the FS Specialty Lending Fund and Blue Rock’s Total Income Plus Real Estate Fund, which saw their market prices drop significantly (up to 40%) upon listing, proving that the risk was always present—just hidden by private valuation methods.

3. Key Arguments and Evidence

• The "Special" Myth: Felix argues that there is no evidence of a "private market premium" when returns are properly benchmarked and adjusted for fees and risk.
• Liquidity vs. Volatility: Public markets offer liquidity at the cost of visible volatility. Private markets offer "smoothed" (hidden) volatility at the cost of total illiquidity. Felix posits that investors are often better off with the former.
• Retail Vulnerability: The push to move private assets into retail channels is driven by the need for financial institutions to maintain high profit margins as public market index fund fees decline. Retail investors are often the "last ones to the party," absorbing the illiquid assets that institutional investors are trying to offload.

4. Notable Quotes

• "You either get volatility, or if you say, 'I don't want to see the volatility,' then you're going to get illiquidity."
• "If this whole thing smells a little bit fishy, I think you've got a good nose." (Regarding the change in fee structures to capture unrealized gains).
• "There is nothing special in private markets... net of fees and properly benchmarked."

5. Synthesis and Conclusion

The current downturn in private markets serves as a validation of the skepticism surrounding these assets. The combination of high fees, lack of transparency, and the inability to access capital during market stress makes them a poor fit for most retail investors. The "special" returns promised by private markets are largely a result of accounting conventions rather than superior economic performance. Investors are cautioned to prioritize liquidity and transparency over the artificial stability offered by private market funds.