Episode 402: The Problem with Private Markets

Episode Summary

Executive Summary: Episode 402 argues that private markets—private equity, private credit, and private real estate—have been sold to investors as lower-volatility, higher-return alternatives, but current stress, gating, and valuation write-downs suggest the risks are at least as high as public markets. The hosts emphasize illiquidity, adverse selection, fees, and opaque pricing, while also addressing counterarguments from Larry Swedroe about illiquidity premia, persistence, and tax efficiency.

Main Topics: PWL’s wealth management model (Priority: 3/5): The hosts clarify that PWL is not just an asset manager; it provides end-to-end wealth management, integrating portfolio management with financial planning, estate considerations, and coordination with other professionals. Why private markets are attracting scrutiny (Priority: 5/5): Private assets are being pushed into retail channels amid claims of higher returns and lower risk, but recent liquidity problems, gating, and markdowns are exposing the gap between marketing and reality. Private equity: returns, smoothing, and exit problems (Priority: 5/5): The discussion questions whether private equity truly outperforms public markets after proper benchmarking and fees, and highlights continuation funds, NAV squeezing, and valuation smoothing as major concerns. Private credit: hidden risk and redemption gates (Priority: 5/5): Private credit is presented as risky lending that often looks stable only because it is not marked to market daily; public BDCs are used as a contrast showing how quickly markets can reprice these risks. Private real estate: liquidity stress and public-market reality check (Priority: 4/5): Private real estate funds are facing redemption pressure in a weak real estate environment, with some considering IPOs that may reveal large discounts to stated NAV. Debate with Larry Swedroe on private assets (Priority: 4/5): The episode revisits Larry Swedroe’s pushback on the hosts’ skepticism, including arguments about illiquidity premia, fee compression, persistence, and tax efficiency, while the hosts respond that the evidence remains unconvincing.

Key Arguments: Private assets are often marketed as offering higher expected returns with less risk, but the hosts argue this pitch is not supported by the economic reality once fees, liquidity, and valuation issues are considered. Illiquidity is not a free benefit: investors may receive a smoother-looking return stream, but that smoothing can mask real volatility and create redemption risk when cash is needed. Retail investors are especially vulnerable because they have less ability to absorb illiquidity, less bargaining power, and are more likely to be sold the least desirable assets when institutions seek exit liquidity. Private equity returns may largely replicate public-market exposures once properly benchmarked, and reported outperformance often disappears after adjusting for smoothing and inconsistent benchmarks. Continuation funds and evergreen structures may create conflicts of interest and adverse selection because managers can sell assets to vehicles they also control, often without a fully market-tested price. Private credit’s apparent stability is misleading; public BDCs show that the same underlying loans can be repriced sharply when markets are allowed to assess them openly. Private real estate funds are not obviously superior to public REITs and are now facing the same liquidity and valuation pressures as other private assets. Larry Swedroe’s counterarguments—illiquidity premium, persistence, and tax efficiency—are acknowledged, but the hosts argue the evidence is either contested or not clearly investable for most investors.

Data Points: Episode number: 402 - The podcast episode focused on private markets and their problems. Private equity fee estimate: around 6% - Cited from Ludo Falapu’s research as total fees that can accrue across layers. Harvard/Yale secondary sale discount: around 11% - Universities sold private equity stakes to secondary buyers at a discount to NAV. Immediate paper return on secondary purchase: 12.3% - Example of buying a fund stake at an 11% discount and marking it back to NAV. Hamilton Lane incentive fees: $58 million - Reported incentive fees collected after changing to performance fees on unrealized gains. FS KKR Capital Corporation performance: significantly down for the 12 months ending Feb. 27 - Public BDC example showing market repricing of private credit risk. BlueRock Total Income + Real Estate Fund IPO drop: from $24.36 NAV to $14.70 close - Example of a private real estate fund listing publicly and trading well below stated NAV. FS Specialty Lending Fund IPO drop: from $18.67 NAV to $14 close - Another example of a private fund revealing a lower market price once public. Canadian real estate decline: worst real price decline since 1975 - Used to explain stress in private real estate funds. Private market secondary sales: $162 billion - Referenced as the scale of secondary market sales last year.

Pivotal Quotes: "After many years of hiding behind sort of a mystique and illiquidity, private markets are really being forced into the light recently." — Benjamin Felix: Opening framing for why private markets are under scrutiny now. "The volatility is still there. You just don't see it." — Benjamin Felix: Explaining return smoothing and the illusion of low volatility in private assets. "Private equities reported outperformance over public markets largely disappears once consistent benchmarks and definitions are applied." — Ludo Falapu (quoted by Benjamin Felix): Used to support the claim that private equity outperformance is overstated when measured properly.

Implications: Listeners should be cautious about private-market sales pitches, especially in retail products. The episode suggests liquidity, valuation transparency, and fee drag matter more than glossy return narratives, and that public-market alternatives may be more honest and investable for most investors.