The Problem with Private Markets: What Investors Must Know

Private Markets Have a Serious Credibility Problem

For years, private markets have operated behind a carefully maintained mystique. Private equity, private credit, and private real estate were sold to investors — first institutional, now increasingly retail — on a single, seductive premise: higher returns, lower risk. It was always too good to be true. The economic principle that higher expected returns require accepting higher risk does not have a private markets exemption, no matter how compelling the sales pitch.

The cracks are now fully visible. Private equity funds are struggling to exit positions. Private real estate funds are gating redemptions — meaning investors literally cannot access their own money. Private credit portfolios are surfacing loans that appear far riskier than originally disclosed. Ivy League endowments that pioneered private market investing are quietly trimming allocations and revising their return expectations downward.

None of this should surprise anyone who looked at the evidence critically. But millions of retail investors who were never shown that evidence may be learning these lessons the hard way — and at significant cost.

The Illusion of Low Volatility in Private Assets

One of the most powerful — and most misleading — selling points for private market investments is their apparent stability. Unlike public stocks, private assets are not priced in real time on an exchange. Valuations are updated infrequently, often quarterly, and typically by the fund manager themselves. The result is a return stream that looks smooth, calm, and uncorrelated with the chaos of public markets.

This smoothness is not a feature. It is an accounting artifact.

Researchers have coined a term for it: volatility laundering. The underlying economic risks of a private equity portfolio — leverage, business cycle exposure, credit risk — are structurally similar to, and in many cases exceed, those of equivalent publicly listed companies. The difference is that you simply do not see the price fluctuate every day. That is not the same as the price not fluctuating.

When researchers adjust private equity returns to account for the infrequent valuation of underlying assets, the apparent diversification benefit largely evaporates. Studies have found that net-of-fee private equity returns can be largely replicated by constructing a portfolio of small-cap and value-oriented public stocks with similar characteristics. In other words, the risk-adjusted outperformance that fund managers advertise may not survive scrutiny once fees, leverage, and smoothed valuations are properly accounted for.

The tradeoff becomes even starker for retail investors. In public markets, you can sell at any time. Your investment may be down, but you retain full control. In a gated private fund, you may be denied redemptions entirely — not because your investment has performed well and the manager wants to protect compounding, but because the underlying assets are simply too illiquid to sell at a fair price. That is a materially different risk profile than most investors signing up for these products are told to expect.

The Fee Problem: Where the Real Returns Go

Private market fund managers are genuinely skilled operators. The evidence suggests that before fees, private equity has generated substantial returns. The problem is that investors do not keep those before-fee returns.

Total fee loads in private equity — including management fees, performance fees (typically the famous "2 and 20" structure), transaction fees, monitoring fees, and fund-of-fund layers where applicable — can aggregate to roughly 6% per year when all-in costs are properly tallied. At that level, it becomes mathematically very difficult for any net-of-fee return to meaningfully exceed what a low-cost, risk-matched public equity portfolio delivers.

This is not a flaw in the system from the manager's perspective. It is the system working exactly as designed. Economic theory predicts that in a competitive market for capital, skilled managers will capture the economic rents generated by their skill through fees, not leave them on the table for investors. Private equity has largely validated that prediction.

The fee problem is compounded for retail investors, who typically pay higher fees than institutional counterparts and have less negotiating leverage. As institutional investors increasingly adopt low-cost index funds for their public market allocations — driving fee compression across the industry — private market products have become one of the last remaining high-margin opportunities for asset managers. The commercial incentive to push these products onto retail investors is enormous and largely independent of whether those investors are well-served by the allocation.

Continuation Funds and the Adverse Selection Risk

The liquidity crisis in private equity has produced some creative, and concerning, financial engineering. When private equity funds cannot sell their portfolio companies to external buyers at target valuations, they have increasingly turned to continuation funds — vehicles that purchase assets from an existing fund, often managed by the same firm.

Enterprises known as evergreen funds have become a prominent buyer in these transactions. These semi-liquid vehicles are designed to be accessible to retail investors, offering lower minimum investments and more frequent liquidity windows than traditional closed-end private equity funds. They sound like progress. In practice, they raise a significant adverse selection concern.

Consider the logic: a private equity manager has portfolio companies they cannot sell to an external third party at the valuation they are carrying on their books. Rather than mark those assets down, they sell them to another fund they also manage — an evergreen vehicle that is actively marketing to retail investors. The retail investor buys into the evergreen fund, providing the exit liquidity the original fund needed. The asset's valuation remains unchanged on paper. No external market has tested whether that valuation is real.

This dynamic is not hypothetical. Secondary market transactions in private equity — including fund stake sales and continuation fund transfers — rose 45% to approximately $162 billion in a recent year, reflecting just how widespread liquidity management through internal transactions has become. For investors entering these evergreen vehicles, the uncomfortable question is: if the underlying assets were attractively priced, why couldn't the manager find an external buyer?

The NAV Squeeze: A Case Study in Paper Gains

The mechanics of private market valuation have produced one of the more striking anomalies currently visible in the industry: the NAV squeeze.

Here is how it works in practice. A university endowment — say Harvard or Yale, both of which have been active sellers of private equity stakes — needs liquidity to fund operations. It sells a stake in a private equity fund to a secondary buyer at a discount averaging around 11% below net asset value (NAV), based on recent transaction data. That is, a position the fund manager values at $100 million changes hands for approximately $89 million.

The secondary buyer, often another private equity vehicle, is then permitted under current accounting rules to immediately mark that $89 million purchase back up to the original $100 million NAV — because that is still what the underlying fund manager says the assets are worth. On paper, the secondary buyer has generated an instant 11% return. Nothing about the underlying businesses has changed. No value has been created. The accounting simply permits the mark-up.

This process has real consequences. Fund manager Hamilton Lane reportedly updated its fee structure to collect performance fees based on unrealized gains — meaning gains that exist only on paper, before any underlying company is actually sold. Shortly after the change, the firm reportedly collected $58 million in incentive fees that would not have been payable under the prior rules. Some market observers have noted that this timing raises questions about whether fund managers themselves have reduced conviction that current paper valuations will be supported when assets are eventually sold to genuine third-party buyers.

What This Means for Retail Investors Considering Private Markets

Retail investors are being actively courted by private market fund managers at precisely the moment when institutional investors — the sophisticated, long-horizon capital that built these strategies — are pulling back. That timing is worth taking seriously.

Here are the key risks any retail investor should understand before allocating to private market funds:

• Illiquidity is not optional. Gating provisions are real and have been exercised recently across multiple asset classes. If you need your capital within a defined window, private market funds carry meaningful access risk.
• Fees compress net returns significantly. An all-in fee load of 5-6% annually is a very high hurdle to clear, particularly in a slower-growth environment.
• Valuations are not market-tested. The price you see on a private fund statement reflects a manager's estimate, not a transaction. The gap between that estimate and a real sale price can be — and has been — substantial.
• Diversification benefits shrink under scrutiny. Once smoothed returns are adjusted for infrequent valuation, the correlation between private assets and public markets rises materially.
• You may be the exit liquidity. The push to open private market funds to retail investors coincides with a period when existing institutional investors need to reduce exposure. That sequence is not necessarily coincidental.

None of this means every private market investment is a bad investment for every investor. There are funds that have outperformed on a net-of-fee, risk-adjusted basis — just as there are actively managed mutual funds that have outperformed index funds. The difficulty, as decades of evidence in public markets have already demonstrated, is identifying those funds in advance rather than after the fact.

For most retail investors, the combination of high fees, illiquidity risk, valuation opacity, and the structural incentives currently pushing these products onto unsophisticated buyers represents a set of headwinds that the average private market fund is unlikely to fully overcome. The burden of proof should be on the fund manager to demonstrate why their product justifies those costs — not on the investor to disprove it.

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This article is for informational purposes only and does not constitute financial advice. Always consult a qualified financial professional before making investment decisions.

Frequently Asked Questions

What is the core problem with private market investments? The central issue is that private markets have been sold on the premise of delivering higher returns with lower risk than public markets — a combination that contradicts basic financial economics. Net of fees, the evidence suggests most private equity funds deliver returns roughly in line with risk-matched public equity, while charging fees of roughly 5-6% annually, carrying significant illiquidity risk, and reporting valuations that are not independently market-tested.

What does 'gating' mean in private funds, and why does it matter? Gating refers to a fund's ability to restrict or suspend investor redemptions — in plain terms, telling investors they cannot withdraw their money. This typically occurs when the underlying assets are too illiquid to sell quickly at fair prices. Gating has become notably more common in private real estate and private credit funds recently, and it represents a material risk that many retail investors do not fully appreciate when entering these vehicles.

What is volatility laundering in private equity? Volatility laundering describes the phenomenon where private assets appear less volatile than equivalent public assets solely because they are valued infrequently — typically quarterly, by the fund manager — rather than continuously in an open market. The underlying economic risks have not changed; only the frequency of reporting has. Research suggests that when private equity returns are adjusted for this smoothing effect, the apparent diversification benefit relative to public equities largely disappears.

Should retail investors avoid private markets entirely? The evidence warrants significant caution rather than an absolute prohibition. The case for private markets is weakest for retail investors specifically: they typically pay higher fees than institutional investors, have less ability to negotiate terms or conduct due diligence, and may be entering at a point in the cycle when sophisticated institutional investors are reducing exposure. For investors who genuinely have long time horizons, high liquidity reserves elsewhere, and access to institutional-quality fee structures, the calculus may differ — but those conditions describe very few retail investors. Independent financial advice tailored to individual circumstances is essential before making any allocation.

What are continuation funds, and why are they controversial? Continuation funds are vehicles that purchase portfolio assets from an existing private equity fund — often managed by the same firm — providing that fund with liquidity when it cannot find external buyers. They are controversial because the fund manager controls both sides of the transaction, raising questions about whether the transfer price genuinely reflects market value. When evergreen funds accessible to retail investors serve as the buyer, there is a risk that retail capital is being used to provide exit liquidity for earlier investors at valuations that an independent third party may not have agreed to pay.