Private Equity & Credit Landscape - Liquidity vs. Sophistication

Private Markets Landscape - Liquidity vs Sophistication.pdf

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A question that is often posed throughout conversations with clients is “should I be allocating part of my portfolio to private investments?” Private markets have ballooned in asset size over the past decade. Roughly a $3-4 trillion asset class 10 years ago has grown close to around $22 trillion as of late 2024. From endowments to pension funds, to large financial institutions, and now retail investors like us, it seems as if private market exposure has been deemed a necessity for any investor. Some argue that it is a better place to deploy capital than public markets such as the traditional stock & bond markets. For example, Harvard University’s roughly $57 billion endowment has roughly 41% of their investable assets allocated to private equity markets. Given its significant growth over the years, as well as their 1.5-2% internal annual fees (estimated average) plus potential performance fees (can be anywhere from 10-20% depending on the fund), it almost seems as if investors are more and more willing to pay a significant premium for less liquidity and even less transparency. That said, how do private markets/funds actually operate, and more importantly, is it an asset class worth allocating to right now?

For those who are not familiar with private markets, it is exactly what it sounds like. Companies that are not offered via public markets but are still offered to investors via funds by companies such as Blackstone, Apollo, Ares, and KKR, just to name a few. The push into the retail space (investors like you & I) has been significant over the past handful of years, with more funds being offered on platforms each year. From a funding perspective, most private funds operate with what’s called a “capital call” (or drawdown/commitment) structure. They are funded upfront from investors via capital commitments. For example, XYZ Company will launch “Private Fund 1” with a certain capital threshold and take in money from investors until that threshold in the fund is met, all while looking for companies to purchase in the meantime in order to invest the capital that has been raised. When that threshold has been met, the fund is cutoff from new investors, and XYZ Company will launch “Private Fund 2” and repeat the process. From an investor’s perspective, your money is not automatically allocated and all invested at once (like public market funds do most often). Let’s say you commit $250,000 to Private Fund 1. XYZ Company still needs to go out and find companies to purchase, so your $250,000 will be “drawn down” incrementally over time via capital calls. Maybe $50,000 the first time, then another $50,000 the month after and so on until the full amount is invested. Once fully invested, most funds have a time period in which they plan on returning your initial investment (usually 5 or so years), with distributions being paid along the way.

That said, why has there been such an increasingly amount of interest in private markets over the past decade, specifically with individual retail clients like ourselves? In our view it boils down to three things: returns, how it is sold to investors (diversification purposes and it’s “non-correlation to public markets”), and so we can tell our friends on the first tee at the local club which “sophisticated” private funds we own. Truth is they’re not that sophisticated. They go out and buy privately held businesses with investors’ money, plain and simple. Our issue is how the market operates from a liquidity & transparency standpoint, or the lack thereof. From an operational standpoint, think of private markets like you would the housing market. The sales process tends to be slow, and liquidity can often be determined by economic factors (interest rates, supply/demand, etc.). In our opinion, when there is a lack of funding, true price discovery (industry term for how much an asset is actually worth) becomes a major problem and dislocations begin to emerge. To build on the housing market analogy, home prices have skyrocketed over the past 5 years and albeit there have been many factors as to why, there are two main reasons that can be attributed to basic economics. There has been ample liquidity in the financial system due to post-covid policies which has led to a large decrease in housing supply due to individuals and investors purchasing homes with that liquidity. This is economics 101, when there is more demand than there is supply, prices go up. But what happens when that dynamic flips in a relatively illiquid asset class?

Unlike public markets where you can sell a stock at the click of a button at whatever the price is that minute, prices can take time to properly adjust, particularly downwards, which can lead to prices staying elevated until companies/people are forced to sell. For housing it may mean someone that is looking to sell thinks their house is worth more than it actually is, so they keep it on the market for an elongated period, or they take it off the market, or they don’t list it at all. That is until they are forced to sell due to outside factors.

Private equity/credit markets operate very similarly. Most funds even have a safety valve in the form of redemption limits (maybe only 5% of the fund can be redeemed per quarter). They say this is to protect investors from themselves by making sure you do not sell at a time of panic, but that works both ways because it also behooves them to have your assets locked up. Outside of continuing to collect internal fees, much like us, private companies can borrow against the assets on their books (we do this through HELOCs, securitized lending, etc.). So, keeping prices artificially high at any given period can also help maintain their borrowing capacity. Now this isn’t an accusation, it is just an observation. That said, the four firms mentioned earlier control roughly 30-40% of the private equity market throughout the world. Do with that what you will.

Since 2021 to the end of 2024, the number of companies that have been sold within the private equity market has been roughly cut in half. It has been widely reported over the past few years that there has been a significant “backlog” of assets that can’t be sold due to many reasons. “The largest “exit backlog” in two decades” according to McKinsey’s Global Private Markets Report, and “roughly $3.2 trillion in unsold assets” according to Axios. Meaning there are a ton of companies that managers want/need to sell, but there aren’t any buyers at the prices being asked. This can keep prices artificially inflated until they are forced to sell assets at whatever is deemed fair market value. Simply put, prices won’t properly adjust until assets start to trade hands. In the meantime, a majority of these firms either price their holdings themselves internally or use an outside company to price their holdings (a company that gets paid a fee by the investment manager to price their assets). The biggest surprise to most people is a majority of these assets are only “marked-to-market” on a quarterly basis. That would mean owning an individual stock and not knowing its actual worth for 3 months. We would argue that this is less than transparent.

So, why is all of this important? The most common reason used to pitch private equity/credit (equity in particular) to investors is for its diversification purposes & that it is not correlated to the stock market. Which, on the surface, seems to be true. In 2022 the Cambridge Associates PE Index (commonly used benchmark for private equity returns) was down roughly -4% to -5%, which compared to the S&P 500’s drawdown of -18% as well as the US Bond Market having its worst year in history being down roughly 13%, makes their claim seem accurate. Since 2022, the S&P has rebounded significantly making all-time highs as we head into 2026, with Private Equity returning roughly 9% and 8% in 2023 & 2024, respectively, but the massive backlog of unsold assets continues to build in the private equity space.

With all of this said, we will end with posing a question to all of our clients and investors reading this. Is it more plausible that in 2022 nearly every major public market throughout the world (both bond and stock) was down anywhere between 10-20% and an asset class that relies on similar economic factors for funding & liquidity was only down 4-5%? Or, hypothetically, does it make more sense that private equity has a massive buildup of assets since 2022 that are looking to be sold (roughly 30-40% of the entire asset class according to McKinsey’s 2025 Private Markets Report), and no buyers to sell them to at the moment which could allow them to maintain elevated asset prices until investments are forced to start trading hands?