March 26, 2026

Episode 402: The Problem with Private Markets

March 26, 2026

In this episode, we unpack the growing tension in private markets—private equity, private credit, and private real estate—and examine whether their long-standing appeal holds up under scrutiny. With increasing pressure to bring these investments to retail investors, the discussion explores how illiquidity, valuation opacity, and complex fee structures may be masking risks rather than reducing them. We break down how private assets are marketed, why their “smooth” returns may be misleading, and what recent events—like gated funds and forced asset sales—reveal about their true risk profile.

Key Points From This Episode:

(0:00:00) Introduction to the episode and overview of private markets as the main topic.

(0:00:39) Clarifying PWL Capital’s full-service wealth management approach beyond asset management.

(0:03:24) Why private markets are under scrutiny and recent negative developments across asset classes.

(0:06:36) The seductive sales pitch: higher returns, lower risk, and low correlation to public markets.

(0:08:32) Private assets explained: what they are and why they appear less volatile.

(0:10:06) “Volatility laundering” and the illusion of stability in private market valuations.

(0:13:51) Retail investors entering private markets and the risk of adverse selection.

(0:15:09) Liquidity challenges and the growing issue of gated funds.

(0:18:33) Why illiquidity is especially problematic for retail investors with uncertain cash needs.

(0:20:41) The debate over whether an illiquidity premium actually exists.

(0:23:56) Trade-offs between liquidity and volatility in portfolio construction.

(0:30:41) Evidence on private equity performance vs. public markets and the role of fees.

(0:31:39) High dispersion in private equity returns and challenges of manager selection.

(0:33:00) Continuation funds and evergreen structures raising valuation concerns.

(0:36:00) Secondary market sales, NAV manipulation concerns, and “NAV squeezing.”

(0:40:00) Private credit risks, gating, and comparisons to publicly traded BDCs.

(0:44:00) Insurance companies allocating to private credit and potential systemic risks.

(0:45:02) Private real estate funds, liquidity issues, and IPO valuation shocks.

(0:47:43) Public listings revealing large gaps between NAV and market prices.

(0:49:34) Summary: private markets may be as risky as public ones, with added complexity.

(0:49:44) Larry Swedroe’s critique and the debate over private market outperformance.

(0:52:00) Illiquidity premium vs. “smoothing as a service” debate.

(0:54:00) Manager skill, persistence, and the challenge of accessing top-tier funds.

(0:56:50) Final reflections on ongoing research and the importance of informed debate.

Read The Transcript:

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We're hosted by me, Benjamin Felix, Chief Investment Officer, and Cameron Passmore, Chief Executive Officer at PWL Capital.

Ben Wilson: Good to be back. This is episode 402, where we're talking about the private markets or the problems with private markets, which is a pretty interesting topic and has been a hot topic in news headlines recently.

Ben Felix: Good to be back recording with you guys. We haven't recorded an episode like this in quite a while. We had a long string of guest episodes. Good to be back.

Dan Bortolotti: Good to be here.

Ben Felix: Before we jump into the private markets content, I did want to just address something.

I've had a couple of conversations recently where people had no idea what PWL does, which to us is a little bit concerning because we do expend a lot of energy creating content and putting ourselves in the public eye so that people know who we are and know to reach out to us if they're looking for the services that we provide. When people don't know what we do, it's like, oh, we should probably make sure people know what it is that we do. In both of these cases, these people thought that PWL only does asset management.

They'd written us off as an option for what they were looking for, which was more of a holistic wealth management type service because they thought we only did asset management. I just wanted to mention upfront here that PWL is a wealth management firm. We do manage investment portfolios using low cost index funds and dimensional funds.

But, as discretionary portfolio managers, we look at the client's full financial picture and their long-term plan in the course of giving investment advice. That includes running financial planning projections, considering how the investment advice we are giving integrates with the other major financial planning areas. Then the other thing is that since we're managing the investments, which connect to really everything else in someone's life, we do generally end up sitting in the middle of the client's financial situation, coordinating between other professionals like lawyers and accountants.

Us sitting in the middle there really ends up taking a lot of the mental load off of the client who instead of them having to be central to everything that's happening and coordinating everything, we're able to take a lot of that on.

Ben Wilson: Yeah, exactly. It's a truly end-to-end wealth management offering because we need to know about everything that's going on in the financial lives of our clients to give good quality advice.

Dan Bortolotti: It's very difficult to make investment decisions for a client without understanding all of those things. And yet, we know from others in the industry and talking to new clients, for example, that it's pretty common for people to get investment advice that's almost completely separated from their personal situation. This comprehensive way that we do it, integrating the investment management with the planning, it's becoming a more popular model, of course, but it's certainly a much better one for the client.

Ben Felix: We've always firmly held this belief that to give the best quality investment advice, we really need to have that full end-to-end picture that goes right through to the estate plan. The estate plan, just using that as one of the examples, that does interact with asset allocation and even when you should buy and sell different securities in the course of investment planning. All that to say, we are a wealth management firm.

We do look at the full financial picture, not just the portfolio. All right. Jump into our main topic.

Dan Bortolotti: Let's do it.

Ben Felix: I do want to preface this by saying that after I released my video on this topic, which is a few weeks ago, when this episode gets released, Larry Swedroe, who we all have lots of respect for, pushed back pretty hard on several of the points that I made in the RR community. I think we ended up having a pretty good back and forth discussion, which is still ongoing at the time that we're recording.

I'll relay the main points that Larry made and my responses, which I'd also made in the community after I've gone through the topic. After many years of hiding behind a mystique and illiquidity, private markets are really being forced into the light recently. There's been a ton of media coverage of some of the things that are happening in private markets.

Private equity, private credit and private real estate, infrastructure too, but I'm not going to address that in this discussion. Private assets in general have been sold super hard to investors on the premise that they offer higher returns with less risk compared to public markets. As fund managers push for these investments to become more accessible to retail investors, which is another big thing that's happening right now, I think there's a lot of caution warranted.

I've always been skeptical of private assets. I think my skepticism is being validated in real time here. 2026 has been a wake up call for everyone who was convinced that private assets were special.

Private markets are really having a bad time right now. Some private equity funds are having trouble selling their holdings, often resorting to selling private company shares or private equity fund stakes to themselves, which is a pretty interesting concept. We'll talk more about that in a minute.

Some private real estate funds can't sell their underlying holdings to meet investors' demands for liquidity and are having to gate, which is kind of industry lingo for locking up the funds, telling investors they can't have their money back. Private credit funds, many of which are also gating redemptions, are realizing that a lot of the loans they've made might have been pretty risky. I think they kind of knew that.

I think investors are realizing, oh, these loans were quite risky, which has not been apparent because in many cases, the private credit funds, because they're not marking the assets to market value, they look very stable. That's been changing in recent history. Personally, I've not been too surprised to see any of this.

It's kind of like, okay, this is finally happening. Long time coming. I think a lot of investors in private markets will be surprised just because of the way that this stuff has been sold.

Again, fund managers have pushed private market investments really relentlessly on this premise that private market investing offers lower volatility and higher expected returns than what can be found in public markets. That's a compelling sales pitch. To me, it just never smelled right.

In the rest of this discussion, we're going to discuss each of the major private asset classes, private equity, private credit, and private real estate. As I mentioned before, we're going to leave infrastructure out. That's a different topic for another day. We'll review what the evidence says and what is happening in each asset class right now.

Ben Wilson: Go back to your sales pitch comment. I think that's important because the reality is that most of these private market products are so complex that the average investor and could even go as far as saying, even a lot of advisors don't fully understand the intricacies of each product. The way they're pitched sounds like an attractive, lower volatility, lower risk, not very correlated to the public market.

It sounds really sexy. Of course, I want that. I can get better returns with less risk than why wouldn't I add that into my portfolio?

It's attractive to the investor, but you have to actually dive deep to fully understand to see what you're getting yourself into.

Ben Felix: Yeah. To your point, Ben, I think we did an episode with my friend Aravind. I think that was last year, December of last year.

We did that episode titled, Is Anyone Doing Due Diligence? It was basically like these products are super complex and even a lot of advisors are probably not doing the level of due diligence that maybe would ideally be done on these products because it's hard because they are so complex.

Dan Bortolotti: It may be an attraction here though in that superficially, I guess, they don't seem complex. I think on the surface, investors understand, okay, you're investing in businesses that are not publicly traded, or you're investing in real estate. We all understand what those are.

You're making loans to businesses or individuals who are not getting conventional financing, whatever. On that level, compared to something like covered calls and leveraged ETFs and all these things that are on their surface complex, these may lull people into an idea that they're common sense, straightforward investments, and they don't realize how the products are structured, how the funds are, what restrictions they might have on them. The complexity might not scare people off until they start to scratch the surface a bit.

Ben Felix: The narratives are simple, but the products are complex. Private assets are just assets like stocks, equity holdings in companies, loans made to companies, infrastructure assets, which I mentioned we're not going to go into much detail, and real estate assets. They're just assets that have not been listed on a public exchange.

Now this means that you can't log into your brokerage account and trade private assets like you can trade publicly listed assets. It also means that the underlying company's disclosure requirements are not as strict. The filing requirements to be publicly listed are very stringent.

You just don't have that as a private company. Since they don't trade on public exchanges, the prices of private assets are not being set throughout the day like what we see with publicly listed stocks, bonds, and REITs, which makes them appear less volatile. Now appear is the key operator there.

As we'll talk about, I think they probably are at least as volatile as public equities under the hood. The economic fundamentals, if the assets were mark to market, they're no less risky. They just show up that way on paper.

Ben Wilson: It would actually feel less risky to a client too. If you don't see the fluctuation, from an investor behavior perspective, ignoring the complexity for a minute, that piece is actually positive, but it's really uncertainty or ambiguity in the actual price because you don't know what it is. Whereas public market, you could see it jump two or three or 4% in a day, which is stressful to see. This could be happening behind the scenes without actually realizing it.

Ben Felix: Correct, which is a concept that Antti Ilmanen, when he was on this podcast a long time ago, not that long ago, it was like episode 200 and something. He referred to this as smoothing as a service, or Cliff Asness has called it volatility laundering. The volatility is still there, you just don't see it, which may be appealing to some people, which has implications for asset prices, which we'll talk about in a bit.

For a long time, private market investments were largely contained within the realm of institutional investors, entities like university endowments, pension funds, and not-for-profit reserve funds. These are entities with lots of capital, extremely long time horizons, and often professional staff. I would argue, and I have argued in past video with supporting evidence, that private markets are even questionable for those types of investors.

More recently, private assets have been increasingly pushed onto retail investors, whether they're asking for them or not. They've really been shoved down people's throats, excuse the expression. I know in my job as CIO of PWL, I see these sales pitches all the time.

They only seem to be increasing. We know they're only increasing. The Ontario Securities Market Regulator, the OSC, is being pressured to authorize a new class of mutual funds that can hold higher risk private assets aimed at retail investors.

Similar things are happening in the US, targeting the retirement accounts of American families, that's the 401k, getting private assets into 401ks. Even if you could convince me that institutions should be investing in private assets, which I don't know if you can convince me of that, but if you could, I think the case for retail investors is even harder to make. As we talked about a minute ago, the underlying assets are illiquid.

The fees are high and complex. The agreements governing how fees work, how liquidity works, the whole structure works is complex. It's not easy to understand.

The issue, I think, is that there's a huge incentive to convince retail investors otherwise. Retail investors in aggregate have a lot of money. The fees charged by private market fund managers make them, make these products very attractive for the financial institutions selling them.

This is particularly true in a world where investors are increasingly adopting low-cost index funds for the public market investments, driving down profit margins for financial firms. It's even beyond that, actually. Index funds are driving down asset management fees, period.

The Vanguard Effect, which we talked about in episode 400, or I don't know if we talked about it directly, but it was at least alluded to, that index funds have driven down fees for index funds, but also for active management. The margins in asset management are getting smaller, which makes a higher margin product like private markets really, really attractive. Then another issue that's particularly cynical is that retail investors are a huge potential source of liquidity for anyone currently invested in private markets who wants to get out.

That liquidity has been a big problem for private markets lately. We'll get more into that later, but this leads to potential for adverse selection, where retail investors who are like, well, we're going to democratize private assets. Come on, retail investors, get on in here.

Retail ends up getting saddled with the illiquid stuff that nobody else wanted to hold, that couldn't be sold to somebody else. All this retail money comes in and that's who gets to buy those non-desirable assets. All this is happening, these private assets are getting pushed onto retail.

There's a debate going on whether that's a good thing or not. Then in real time right now, the current investors in these funds have been forced to learn that their private market investments are pretty risky, riskier than they appeared based on their paper volatility. Any comments from you guys before I keep going?

Dan Bortolotti: I'm interested in your point about retail investors getting saddled with bearing the brunt of the illiquidity burden that institutional investors should otherwise carry. I think that there are other precedents for this as well. This idea that individuals can invest like institutions.

In theory, it sounds great. It sounds like opportunities to diversify beyond investments that have traditionally been available to retail investors. But once you add one or two middlemen, any advantage is lost, right?

I mean, like you said, you could probably convince me that institutions should include private assets as part of their portfolios. If they're managing tens of billions of dollars, you can maybe make a compelling argument. It's not that great of an argument, but I can at least accept that you could present one.

For the average retail investor, what, the global stock market is not diversified enough for you? It's just really unconvincing. What do you think you're going to be left with after the institutions have chosen the assets that have the best risk return trade-off? It's a bit of naivety, I think, in there.

Ben Felix: The adverse selection piece is really important. The liquidity thing is like, usually, private equity funds, just using private equity as the example, they want to turn over their holdings, whatever it is, every three, five, seven, whatever it is years. They want to sell the underlying private companies and return that capital to investors, but that has been becoming increasingly difficult.

A lot of these private equity funds are not able to sell their holdings right now, and they have not been able to sell them for a bit. They're accumulating this big log jam, as one article that I read called it, of unsold private company shares, which in order for the current investors in those funds to get liquidity, there needs to be new buyers. Somebody has to buy this stuff, but they're not able to sell the companies for a reason.

That's just the adverse selection concept, which I think is worth keeping in mind. Recently, we have seen private funds write down the value of their assets, and we've seen them tell investors they can't have their money back right now. That's the concept of gating that I talked about earlier, which is happening more and more.

It's not great. If you're an investor in a fund, and you decide you want to sell, and they say, nope, sorry, you can't have your money back. That's not fun.

Ben Wilson: There's also usually pretty uncertain time periods when gating happens. It's like, yes, it's locked up, but it's not always like, okay, in two months, you'll be able to redeem. We got to figure some things out, and we hope to open it back up, but it's not always certain, and there's different outcomes that can happen depending on the situation.

Ben Felix: We've had to deal with this at PWL. In some cases, we have inherited, in various ways, private funds, and we've had to deal with this. It's not fun.

Not just recently, there have been other historical examples. We've had to deal with, okay, we have this asset that we can't sell, or we have a window every quarter where we can sell some. It's not a good experience.

Usually, when a fund gets gated or locked up, it's because the underlying assets are not performing well. This is not great. The other interesting thing that's happened is we've seen some of the biggest historical proponents of private market investing, which are Ivy League endowments.

They've started to dial back their exposure a little bit. There was an article that I read on that. They've also started to lower their expected returns for their private market allocations a little bit, which is also interesting.

There are some large wealth management firms in Canada that have been pretty aggressive about promoting their private market funds and just private market investing more generally, while also being quite vocal, criticizing the traditional 60-40 stock bond portfolio, calling the 60-40 portfolio is dead yet again. Those same firms now have had to write down the value of some of their private funds by pretty significant amounts. You get this years of up to the right stability and then this one, boom, drop because there was volatility in the interim.

They waited until they had to, I guess, to mark down the values. I don't know. It really shows that the smooth up to the right chart was not real, for lack of a better way of saying that.

That same firm, and I don't want to name them necessarily, but they've just been very vocal about this type of investing and basically, implicitly saying that the way PWL manages assets is insufficient because we're not doing private market investing. They've had to write down the value of one of their funds significantly and they've had a bunch of their funds gated. There again, they're having to tell investors that you can't access your money right now, because the underlying assets are illiquid.

Dan Bortolotti: The illiquidity side of this is so important for retail investors. It's one thing if you're an institutional investor and this is a small part of your portfolio and you've got lots of other liquid assets and you maybe don't need a lot of money in any given year, whatever it is. But with a retail investor, look, your needs change from time to time.

Look, I've even seen it working with clients buying GICs that we ended up regretting. Now, GICs are illiquid, I get it. The thing is though, you know when they're going to be redeemed and you know exactly what your return is going to be and you accept the illiquidity, because you get a little higher return compared with a similar investment.

But you have to really limit the number of GICs that you're going to use for a client. And if you're going to hold them, you're going to hold them in a retirement account for a younger person or something where you know you're not going to need the money. I guess my point is, you better be expecting a very, very high premium compared with a liquid investment.

If you're going in, and I don't know what that premium is, but I'm thinking for me, if it's not double what I would expect from an equity-like liquid investment, I'm not interested. Because the illiquidity cost is too high for people who don't always know what their future liabilities are going to be. To me, the nightmare is you put a significant amount of your savings into a fund like this and it gets gated.

Look, I have a couple legacy holdings that have come over with clients from many years ago that we still have that we can't get out of. They have now rolled into RRIFs. At some point, that money is going to come out and we can't get it out.

The illiquidity is really, to me, what scares me the most. If you could price these things every day and you could get out of them even with monthly or quarterly liquidity, then maybe. But of course, the argument is the reason that you can expect higher returns is because of the illiquidity and these other characteristics.

But it doesn't become a very compelling argument to me at some point.

Ben Felix: Is there – and this is one of the things that Larry and I went back and forth on. Is there an illiquidity premium? The two competing forces there are what you just said, Dan, that you better expect compensation for taking on that illiquidity.

But then the competing force is smoothing as a service where people may be willing to overpay for private assets despite the illiquidity because it's going to make investment returns look smoother. From our seat, if we're portfolio managers, as we are, and we're worried about our clients panicking in a down market or we're worried about our performance relative to a public market's benchmark, we might have a big incentive to include private assets because of the way that they affect paper returns. Yeah, there's illiquidity.

But if we can say, hey, client, your portfolio is not down as much as the market. How great is that? We may be willing to pay more for that.

Dan Bortolotti: I accept that as a potential appeal. Do you think that investments that are not mark to market every day, this illusion of no volatility has some value for anxious investors? Just how far do you want to push that point?

I mean, if it truly is an illusion, like if it is a volatile asset and you just don't think it is, then at some point, that's probably going to break.

Ben Felix: This, what we're talking about is like one of the inherent trade-offs in private markets. You do get less reported volatility because the underlying assets are valued infrequently, but you might be denied access to your money if the private fund doesn't want to be forced to sell its underlying illiquid assets when you need access to your money, which is fine. That's not private funds being evil.

That's private funds doing exactly what they're supposed to do. They shouldn't be forced to give you your money back because you signed up for an illiquid investment and to manage their private asset portfolio well, they cannot be forced to go into these fire sale scenarios. From the fund's perspective, it makes sense.

From the investor's perspective, it's a trade-off that has to be considered. In public markets, you can pretty easily sell any time, but you're subject to market prices. An interesting question to consider is whether it is worse to live with volatility, but always have access to your money, even if your investment has declined in value, or to be artificially shielded from volatility while potentially being denied the option to sell at a loss.

If your investment's down a bunch, you probably don't want to sell, but it's nice to know that you could. Whereas with a private fund, it's like, no, no, look, the net asset value hasn't changed. We're good.

Everything's fine, but no, no, no, you can't have your money though. No, no, no. Which one's worse?

I don't know if there's a universal answer and maybe the answer is having a little bit of both, a little bit of volatility and a little bit of illiquid smoothing. I don't know. Personally, and for PWL's clients, I generally prefer liquidity and knowing what the assets are worth every day.

Ben Wilson: That timeline uncertainty I keep coming back to, I think that that's important though, because the GIC example Dan brought up, there's a fixed period, fixed term, you can accept that illiquidity for an expected premium. With these private assets, it could be illiquidity followed by, oh, there's actually no value and the fund had to collapse. You may never get asset value from it. Maybe you will, but maybe you won't.

Ben Felix: That's a very good point. I think I mention that later about just how when your fund gets locked up, you're forced to own assets that you know are distressed and you don't know what the outcome is going to be and you're going to continue paying private asset, private fund level fees. Anyway, the inflection point where these things started gaining a lot of popularity was following the 2008 financial crisis.

Likely, at least in part in response to the traumatic levels of volatility in publicly listed assets over that period and also the need for investors to find ways to recover from the losses they sustained in that market decline. If you're an institution in 08, all of a sudden, your assets have tanked in value. Your liabilities, if you're a pension fund or an insurance company, liabilities haven't changed necessarily.

You've got this big shortfall all of a sudden. A lot of institutions started looking at, how can we not live through this crazy volatility again? How can we increase our expected returns to make up our current shortfall?

Private markets were sold as a less volatile place to invest with potentially higher returns, higher expected returns. In my opinion, that alone should be a major red flag, the promise of lower volatility and higher expected returns. People really want to believe that they are not subject to the economics of risk and expected return.

People want to believe they can find a free lunch. Another interesting point here is that a big selling point, just on the topic of institutions, a big selling point always was and continues to be Yale's endowment. Yale pioneered the strategy of going into illiquid private investments.

They did earn years of famously high returns investing in private markets with the legendary David Swensen at the helm. Other investors have always wanted to emulate that outcome. Now, there's been some recent research that's quite interesting, basically showing that while Yale did perform well, the idea that they earned 30% annualized returns in private markets, which is the number that gets thrown around, was probably not what happened.

Those 30% per year returns over a pretty long period of time were based on IRRs, which can be very, very misleading, particularly when early returns are high. When you look at Yale's returns, they're much lower. Anyway, it's just an interesting point.

My view on private assets has always been that net of fees and properly benchmarked, there's nothing special in private assets. That can be contentious. We'll talk more about that.

I think that point only gets more true in the realm of retail investors, who generally pay even higher fees. Adding onto that, the issues of adverse selection that we've already talked about. Now, again, this can be contentious.

Do private markets outperform public markets? That's an unsettled debate. I do acknowledge there's a lot of room for nuance.

There are some good private market funds, at least after the fact. Maybe in some cases before the fact, there is some persistence in private markets where you can pick good managers who will then continue to outperform. There are also good public market funds.

I don't know if that means we should start embracing active management. On balance, when you look at the data in private markets, I'm just not convinced that the sales pitch matches the economic reality. We'll look at each asset class real quick here.

There is some pretty interesting stuff happening in each one. Private equity invests in private companies, attempts to increase their value and then exit the investment. If they can, which has been a struggle recently, as we mentioned earlier, tries to exit the investment at a profit.

Private equity has multiple underlying strategies with the two largest by assets being buyouts and venture capital. Buyouts is the largest segment by assets and that's where firms acquire a stake in a larger and more established private company, try to improve it financially and then sell it at a profit. Venture capital invests in early stage high growth companies with the expectation that a small percentage of those companies will be massively successful while many will lose money.

Venture capital tends to have very skewed distributions because of the way that they invest. They'll have a few really, really big winners and a lot of their investments will be losers in many cases, total losses. That isn't necessarily a bad thing.

Venture capital can still perform well despite the skewness, even because of the skewness. The private equity industry's value proposition for investors, in my view, really rests on two main pillars, diversification relative to public markets, which is an interesting question, whether there's actually diversification there, and market beating returns, which is an even more interesting question. These are testable claims, sort of, but the data can be pretty noisy.

I'm not going to go through all the research on this topic. We have, in past episodes, gone into more depth on what the research says about private equity. We've also had Ludo Phalippou on who has done a lot of the research on private equity.

We've had a conversation with him. People want to dig in to this stuff more. They can listen to those episodes.

A big point here, and this is one of the points that can be quite contentious, is net of fee private equity returns can be largely replicated using public stocks selected to match the characteristics of private equity holdings. That's a big point. Another important point is that when you adjust private equity returns for the fact that private company shares are not valued every day, there is a dramatic reduction in any diversification benefit that may have been observed with raw private equity, with the smooth private equity returns.

I mean, another way to say that is that they're a lot more volatile and a lot more correlated with public markets than the private equity returns appear, sort of, on paper. That's that concept of volatility laundering or smoothing as a service. Just because you don't see the price change every day doesn't mean that the asset's value isn't fluctuating.

A private equity fund might look really stable on paper while its underlying economic risks are very similar to, or maybe even more extreme than, public market equivalents. Another issue is that there's massive dispersion in private equity fund returns, meaning there's a huge gap between the best and worst funds, which increases the penalty for choosing the wrong funds.

Dan Bortolotti: I think that part, Ben, I was just saying, is going back to the IV portfolio, with these famous portfolio allocations that institutions gain so much attention for, they cannot be replicated. Because it's one thing to say, well, we invested in broad market US equities, you can do the same. It's another thing for an institution to say, we bought 1,000 acres of timberland in the Northeastern US, you should do the same.

The dispersion is where everything breaks down here, right? It's just not a replicable investment strategy on the retail level.

Ben Felix: Just on performance, I want to read a quote from a recent paper from Ludo Phalippou, just so it's not me hand-waving this away, this is coming from Ludo's research. He says, "private equities reported outperformance over public markets largely disappears once consistent benchmarks and definitions are applied. The average PME, that's the public market equivalent, which is a way of measuring private equity performance, PME values remain near parity with appropriate public equity indexes."

That is debated in the literature. There are other papers that find outperformance. Ludo says, when you do it properly, there's no outperformance.

Just the fact that this point is contentious, I think is interesting and we'll come back to that later. Ben, you had something?

Ben Wilson: Yeah, I just find that fascinating. It makes me think of investor behavior. Everybody is always trying to find the next best thing that's going to give them an edge overthe market.

This is just another category of possible outperformance or the hope of possible outperformance.

Ben Felix: Another interesting point is that the pre-fee returns of private equity have been massive. It's the net of fee returns that have been in line with public markets. They tend to charge high fees and there are multiple layers of fees.

Ludo said that total fees can end up being around 6%, although Larry says fees come down a lot relative to the historical data, which is another interesting point that we'll come back to later. The fee problem is not the only issue plaguing private equity right now.

The current state of private equity, as we mentioned earlier, is that a lot of funds have been unable to sell their holdings. Not to meet investor redemption requests necessarily, but just to turn over their holdings at a normal pace. The result has not been falling prices for these unsold companies, which is probably what we would see if they were publicly traded companies.

Instead, it's shown up in the rise of more creative ways to get cash back into the hands of investors. One prominent example of that is something called continuation funds. That's a fund that buys portfolio assets from an existing private equity fund, often managed by the same manager, to give the fund, the initial fund, liquidity.

Now we have these continuation funds. An increasingly common investor in continuation funds are a relatively new structure called evergreen funds. These are semi-liquid vehicles that promise ease of use for investors.

It behaves more like a mutual fund instead of a traditional private equity fund. It also gives fund managers flexible capital, which can be used to support continuation funds and make other private market investments. Evergreen funds have typically lower barriers to entry than a traditional private equity fund.

Because they offer more liquidity, they're supposed to be more accessible to retail investors. Now these things have become an important source of secondary market capital. That's the continuation fund idea.

Buying private equity holdings from existing private equity funds. They raise a major concern, which is that the fund manager often controls both sides of the deal. If the evergreen fund is buying an asset from another private equity fund.

This makes the accuracy of the secondary market valuations murky. I think it creates conditions for adverse selection. I think a reason that investors can buy into these evergreen funds relatively easily is that the manager has investments in existing funds nearing maturity that they have not yet sold.

There's this structural need for exit liquidity to pay off original investors in private equity funds. As we mentioned earlier, private equity funds typically want to exit their investments to an outside buyer after a few years. If they instead sell the assets to an evergreen fund that they also manage, it may indicate that they had struggled to find an external buyer.

Which I think suggests the assets might not be something that you want to buy. I think there's a real risk that you're buying a lemon that the broader market would not have touched at the price that you were buying it for through the evergreen fund structure, a continuation fund structure. Now, that's not necessarily always the case.

Maybe you're getting a great deal. Maybe you're buying into some company that's going to win big in the future. I don't know, but that's the problem.

You don't know. You're not buying at a market tested valuation. Then we add on top of that, of that risk, the valuation risk, that net of fees the average private equity fund has performed in line with public market equivalents.

I would say that investors in these evergreen vehicles may be taking on significant complexity and valuation risk without being properly compensated for it. Another interesting thing that's been happening with the liquidity situation is that some investors have been selling their stakes in private equity funds at discounts. You've invested in a private equity fund, but you need some cash.

The fund isn't liquid, but you can find someone to buy your stakes from you at a deep discount. The thing that has arisen from this phenomenon is something that's been called NAV squeezing. This stuff gets pretty crazy.

An example that I read about is with Harvard and Yale. As we mentioned, they've got pretty significant private equity holdings. Yale was one of the early adopters.

Now, normally these guys would wait many years for their private equity funds to exit companies and distribute the cash back to them as the investor, which is the normal course for those investments. Historically, that has worked out, but recently universities have needed cash and been forced to sell their private equity fund stakes sooner than planned to free up cash to fund their operations. Harvard and Yale have been selling parts of their private equity portfolios to secondary buyers at discounts.

Those discounts have averaged around 11%. This discount is a markdown from the position's net asset value. The fund manager says, this is the net asset value.

This is what we think or what our maybe external evaluator thinks that the assets are worth, net asset value, which is an important concept. Now, the trick here, as I said, this gets crazy. The secondary market buyers can put the purchase price on their own books.

They say, yeah, we bought this at a discount, but they can immediately mark it back up to its net asset value in calculating their own net asset value. If Harvard sells $100 million fund stake at an 11% discount, the secondary market buyer of that fund stake can purchase it for $89 million, but then immediately mark it back up on their books to $100 million because that was the fund's NAV that they just purchased, despite the fact that they paid 89 million for it. This is all kosher with the accounting rules, as I understand it.

On paper, this purchase for the secondary market buyer of the fund stakes generated an immediate 12.3% return. That's $11 million on 89 million, even though nothing about the underlying value of the companies has changed. It's pretty crazy.

Dan Bortolotti: That's a pretty convenient way to juice your returns, isn't it?

Ben Felix: Yes.

Dan Bortolotti: Buy something at a discount and claim it's worth whatever you think it's worth. That's hard to believe that that is all aboveboard. Presumably it is.

I'm not accusing anybody of anything except that that's bizarre.

Ben Felix: As I understand it, it's all totally aboveboard with the way the accounting rules work. Now, there have been a lot of secondary market sales. There were $162 billion of secondary market sales last year.

For the universities, for Harvard and Yale in this case, they were able to free up capital. They got liquidity, which is great. The market mechanism worked for them.

Whether the people in the funds that bought the assets are actually getting a good deal, I mean, on paper they are, but a little sketchy, I think. Now, where this gets even crazier is that some fund managers have adapted their fee structures to accommodate this setup. Hamilton Lane, there's an article, I think in the Wall Street Journal about this.

They updated their fee structure to collect performance fees based on unrealized gains rather than the more typical practice of waiting until underlying holdings are actually sold to calculate their performance fees. They took in apparently $58 million in incentive fees shortly after changing the fee structure, which they may not have otherwise seen for many years under the old rules. I do think this smells a little fishy.

Some people speculate, and this is mentioned in that article, that this change was made by Hamilton Lane because they themselves may suspect that the high paper valuations are not going to last. They're collecting performance fees on that increase from a previous example, $89 million to $100 million. They go, look at the gain.

We'll collect some performance fees. Now, bring this to retail, right? When retail investors are sold on the idea that these private equity funds are generating these large returns, and that retail investors are buying into that, I think that's problematic.

The paper returns might be a lot higher than what you can actually realize by selling the investment. Another current concern is the industry's heavy exposure to software companies. Private equity has gone pretty heavily into software, and there are lots of concerns right now.

Software has been hit in general. People are worried about AI affecting software, whether that's a real concern or not remains to be seen. That's just another potential issue there.

This is also affecting, so that the issues in private equity are also affecting private credit. Private credit has been one of the big funders of the leveraged buyouts that are happening in private equity. In private equity, you go and borrow a bunch of money to buy a company.

Who's lending it to them? It's private credit. Private credit consists of loans to private companies, like a bond, except the loans are not publicly traded, and they're created by non-bank entities like private credit funds or business development companies, or BDCs for short.

These funds raise money from investors and then make direct loans, often with flexible terms and covenants to private companies. The loans by their nature are risky. They're loans to private companies.

Like private equity, private credit funds don't have their assets marked to market daily. This again, allows them to appear low risk, even if the value of their underlying assets would be fluctuating pretty wildly in public markets. Again, like private equity, when the returns on private credit funds are properly evaluated against risk appropriate benchmarks, I don't think there's anything special there, which is, again, that can be debated.

One important point is that similar to publicly traded high yield bonds, private loans often share return characteristics with riskier stocks. They kind of look like a mix of stocks and bonds, if you do like a factor decomposition of their returns. Now, this asset class has seen enormous growth, but it's recently started to see investors wanting their money back.

Due to the illiquidity in the underlying loans, some private credit funds have had to gate redemptions. Again, put yourself in the shoes of the investor. You put your money in a private credit fund to try and get some nice juicy yield.

Maybe you start to feel a little bit uneasy about the underlying assets. You ask for your money back, but the problem is, and you mentioned this earlier, Ben, people usually start to feel uneasy at around the same time. When everyone wants their money back, the private credit fund says, no.

Now again, I mentioned this earlier, that is a feature, not a bug, at least if you're the fund. Private loans are long-term loans. They're not expected to be liquid.

They're not designed to be liquid. Investors in these funds should understand that going in, but that's a lot easier said than done, especially when we're talking about retail investors, as you mentioned earlier, Dan. In some cases, gated funds can be locked up for years.

You also mentioned that earlier, Ben. It can be painful. Publicly listed business development companies are pretty interesting contrast.

Rather than gating, they feel the full force of the market's assessment of the value of their underlying loans. They are publicly traded. It's like a private credit fund that's publicly traded, basically, is what a BDC is.

The FS KKR Capital Corporation is one interesting recent example. It reported an increase in troubled loans and lower investment income from its loan portfolio. The market responded swiftly.

The fund is down significantly for the 12 months ending February 27th. Another one was the MidCap Financial Investment Corporation, similarly marked down some of its loans and was recognized by the market for their honesty and their markdowns got smacked pretty hard by public market pricing. I really think that the publicly traded BDCs indicates how much risk private credit funds are taking.

These things are taking serious hits to their market prices, while private credit funds are like, no, no, no. It's cool. NAV's good, but it probably isn't, especially when you consider that a lot of the funds are being gated.

This is just a fundamental truth. When you have risky underlying assets, you're either going to get volatility, or if you don't want to see the volatility, you're going to get illiquidity. I mentioned this earlier, but one of the problems with illiquidity is that you have to own assets that you know stink.

You have to continue paying fees to own them. To your point earlier, Ben, you don't know if you're actually going to get your money back. You don't know how much value you're going to realize on the gated portfolio.

Here's another one. We talked about NAV squeezing for private equity. This is another crazy thing that's been happening.

Life insurance companies traditionally keep their large cash reserves in stable conservative investments. Private equity firms have been buying insurance companies, and then moving significant amounts of the insurance company portfolio into private credit, managed by the same private capital manager. This is just basic stuff.

Insurance companies take in insurance premiums. They actually have to be able to pay out benefits when someone dies or gets disabled, or whatever type of insurance it is. In the interim, the cash can be invested.

The cash they have sitting on hand can be invested, and the insurance company does get to keep the difference between what they earn on the investments and what they pay out to policyholders. This recent playbook has emerged where private equity is buying the insurance company, stuffing its portfolio with private credit funds from lenders owned by the same private equity company that owns the insurer.

Dan Bortolotti: Are insurance companies not highly regulated in what they can invest in to avoid this kind of thing?

Ben Felix: I would have to look into the details on regulation, but there have been a bunch of articles about this happening. It must be aboveboard for it to be public knowledge that it's happening. I think it is creating this closed loop of risk that could be really bad if the risk materializes in private credit.

Ben Wilson: I don't know the rules either, but if it's happening because private companies are buying it, maybe that's a loophole too. Once you own the insurance company, then you can offer your own products inside of the insurance fund itself. We'd have to dig deeper on that.

Ben Felix: Yeah, I'm not super up to speed on the insurance regulations. This is mostly US-based too. This has been happening all over the place.

These risks that we're talking about with private equity and private credit, I mentioned the publicly listed BDCs, but it's also showing up in the equity values of publicly listed players in this space. Managers of private equity and private credit, or just private funds in general, their share prices have gotten just obliterated in recent history. The market is really recognizing that, hey, there are real potential concerns happening here.

Real quick, I want to mention private real estate. Private real estate funds, they directly own real estate assets like apartment buildings, office towers, and shopping malls. As we talked about earlier, it's a pretty simple narrative.

They can have various strategies, but the general idea of owning real buildings inside of a private fund is consistent across this asset class. They're often not unlike publicly traded REITs, except that the private funds don't trade on the stock market. Like private equity and credit, some of these private real estate funds in Canada for sure, I have not checked out the US, but in Canada, they have recently struggled with liquidity.

I don't think that's too surprising right now. Canadian real estate has experienced its worst real price decline going back to 1975. In recent history, public residential real estate REITs have taken a beating and private fund managers, understandably, don't want to be forced to sell assets that have declined in price.

Now, again, that's fine and that's why their contracts with their investors allow them to gate their funds in the midst of the liquidity crunch for many Canadian private real estate funds. Some are considering going public, which is interesting. Being public means that investors can buy and sell their shares on the open market without the fund needing to sell its underlying assets, but it also exposes the value of the fund's units to market prices.

In the case of this Canadian fund, they have halted redemptions for current investors while they consider going public. I don't know what will happen with this IPO or if they even will choose that direction. They're just considering it, but there are a couple of interesting examples from the US where this did happen.

In November of last year, FS Specialty Lending Fund listed on the New York Stock Exchange at a net asset value of $18.67 per share. On the end of its first day on the market, it closed at $14. Then in December, Bluerock Total Income+ Real Estate Fund began trading on the New York Stock Exchange with a stated NAV of $24.36 a share. At close, the fund was trading at a market price of $14.70 a share.

Dan Bortolotti: That's a bad day.

Ben Felix: That's a 40%. 40% drawdown.

Ben Wilson: That's a very bad day.

Ben Felix: Is an IPO the right way to exit a private fund?

I mean, like I said earlier, you're going to get illiquidity or you're going to get volatility. If you don't want the illiquidity, it's going to show up as volatility as we saw with those two examples. Another, like we talked about with private equity, another fundamental question is whether private real estate funds are adding anything special that can't be found in a public REIT.

I would summarize just real quick on that. There's not a ton of evidence that private real estate has outperformed public. They're really exposed to the same underlying economic factors.

There's not really anything special there. We did hear from Mamdouh Medhat from Dimensional who had done a study on private asset funds that there may be some diversification potential leftover, some meaningful diversification potential leftover even after this return smoothing is accounted for. Maybe there are some arguments there, but the idea that you're going to get much higher returns or much less risk in private real estate, I don't think, similar to the other asset class we talked about, I don't think there's a whole lot of meat there.

Anyway, I think private markets have been sold to investors as a way to increase their expected returns without increasing, and maybe even decreasing, the amount of risk they're taking relative to public markets. Recent red flags in private equity credit and real estate have shown that these assets are at least as risky as public counterparts and maybe hiding additional layers of risk due to high fees, illiquidity and less scrutiny in how assets are valued. I know I can say that I'm very glad that PWL did not jump head first into this space when it started getting pushed really hard through the wealth management channel and toward retail investors.

I hope retail investors will approach these assets carefully as they continue to be promoted. Of course, as always, if you want to know more about PWL's super boring investing philosophy, which is awesome, awesomely boring, you can get in touch with us and talk to one of our advisors.

Dan Bortolotti: Our super boring advisors.

Ben Wilson: Super boring.

Ben Felix: Super boring, like Dan.

Dan Bortolotti: Nodding off just thinking about it.

Ben Felix: Okay, so that was the main topic. I do want to just real quick go through Larry Swedroe's comments. Larry's been a big proponent of private assets.

He holds a big portion of his own investments in private assets and it's his view that investors should be investing in private assets. Someone asked him to comment on my video and he shared his comments in the Rational Reminder community. I'm going to read Larry's comments and offer my thoughts, which I also posted in the Rational Reminder community.

I do want to preface this by saying that Larry, he's a legend. He taught me a lot of what I know about financial markets and investing. I think that's probably true for all of us.

Nothing but respect for him, even if we don't necessarily agree at the moment on this topic. Maybe we will end up agreeing. Maybe Larry will change my mind.

We'll see. Larry says, "Ben's a very smart guy, which I appreciate. Much of what he says in the video is correct.

In fact, five to 10 years ago or so, I would have said the same things. When things change, smart people reevaluate their decisions, not stubbornly sticking to prior decisions based on old facts." Okay.

My response there is on the new facts that private equity may have outperformed. I think there's a lot of issues around whether private equity has, in fact, outperformed. Everything really hinges on that point.

Larry references a recent paper from some of the folks at MSCI who have a huge private markets data business. That paper shows that private equity has outperformed, but a paper in the same journal from past Rational Reminder guest, Ludo Phalippou, explains that, read this quote earlier, "private equities reported outperformance over public markets largely disappears once consistent benchmarks and definitions are applied. Average PME values remain near parity with appropriate public equity indexes."

I think at best, the fact, and I put that in air quotes in my notes, that PE has outperformed is contentious. There's similar research coming out on private credit suggesting that it performs in line with comparable publicly traded assets. I think the fact that this is a debate at all is to me a huge problem.

Eugene Fama referred to this same issue when he was on Rational Reminder years ago. We asked why not include private equity in portfolios since it's part of the market? Fama said, what is the expected return on private equity?

"The data don't give you a good answer to that because they're so self-selected. You only get to see the ones that survived pretty much. You don't get to see how much money was put in there that blew up and was totally lost.

That's very important, very important. If I were on your side of the table and I had to advise investors what to do, I don't know what I would do about private equity because I don't think the data are good enough for me to give you an answer." Just that alone, just the fact that this is a debate to me is problematic.

Larry's next criticism, "Ben, unfortunately missed two very important points. There is a significant illiquidity premium in return for the illiquidity potential." My response is that this statement really depends critically on the evaluation of private equity outperformance or lack thereof, any private asset class.

If we can look and say, yep, it's outperformed. Then, hey, maybe that's evidence of an illiquidity premium. If we don't believe it's outperformed, then maybe there isn't.

Again, I don't think this is super obvious. Antti Ilmanen, when he was on Rational Reminder, explained that people are willing to pay for illiquidity because it provides smoothing as a service. It makes returns look more smooth than they really are, which may diminish or even negate entirely any illiquidity premium.

Larry says, "Ben's statement about returns and risk relative to public markets was true." Larry says that he did write that in his books and articles, "but what Ben sadly failed to mention is that fees have come way down, allowing investors to capture more of the premium." My response is that this really seems to ignore the economics of manager skill, which was thinking pioneered by Berk and Green in a 2004, I believe, paper.

We had Jonathan Berk as a past guest who talked about his research on this topic. "Lowering fees in a competitive market increases the amount of assets that a skilled manager can handle, but it doesn't create automatic alpha for end investors. The economics of manager skill is basically that manager's funds will grow large enough to the point where the benefits of the skill are fully absorbed by the manager and investors earn returns in line with the amount of risk they're taking.

The only way to get outperformance is to identify a skilled manager that the market has not yet identified as skilled. Lowering fees just increases the capacity of a manager, but doesn't necessarily result in alpha for investors. With the massive influx of capital into private markets, it seems sensible to believe that alpha opportunities are increasingly scarce."

Larry says "private assets can be more tax efficient, like real estate, where most of the returns are return of capital, not ordinary income, like 90% plus." That's a reasonable point, but not something that I've honestly spent a whole lot of time digging into because we're not using private funds. "Ben also failed to mention that unlike in public markets, there's strong evidence of persistence in private markets and for good logical reasons, on which papers have been written," and Larry did list some of those reasons.

"If you can gain access to top quartile funds, you greatly improve your odds, which changes the math and the findings of academic papers, which look at averages grayly." This is a tough one. I don't think the evidence here is so strong to support an argument that you should be in private markets.

The strongest evidence of persistence, as I understand it, is in venture capital, where adverse selection is also very strong. The best VC funds won't give you the allocation you want. They just won't.

We've been through this with clients trying to get access to the best VC funds, even with the best connections and so on and so forth, you will not get the allocation that you want, if you can get an allocation at all. Sometimes they just won't answer your calls for the best, like the top VC funds. Persistence in buyouts is in the worst performers.

The bottom quartile buyout funds tend to continue to be bottom quartile, so you can avoid them, but you can't look at past winners and assume that they are going to continue winning in buyouts. There was also a recent paper in the Journal of Private Market Investing that suggested that even if there is some persistence in private equity funds, it's not typically investable persistence based on information that's available at the time of making investment decisions. This is pretty interesting.

Basically, you need to wait until a fund has realized its investments, like sold the underlying holdings and shutter down, fully matured, in order to observe the performance that may predict future performance. The managers are typically raising their next fund before their previous fund has fully distributed. Anyway, persistence could be a good argument to be in private markets, but I just don't know if the data are that convincing, similar to the outperformance concept more generally.

Larry says," Ben failed to mention that private assets are actually less volatile in valuations due to the fact they're not influenced by investor sentiment and panic selling where you have massive market impact costs in panics, but the underlying businesses have not been impacted." I struggle with this one. Investor sentiment is still there in private funds.

It shows up in funds gating redemptions rather than mark to market volatility. I think that's what we're seeing happening right now. Larry says, "tell Ben to invite me on the podcast so we can shed more light on the topic."

I'm totally down to do that, but I do want to spend a bit more time exploring the topic first. All right, that is it. Any parting thoughts?

Ben Wilson: I find that just the discussion is interesting and it's good to have these healthy debates to explore both sides so that investors can make an informed decision one way or another.

Ben Felix: We'll keep exploring the topic. There are some other interesting guests that I'm interested in talking to and totally open to having Larry on at some point, but I do want to do a bit of my own exploring first. I already know what Larry's going to say and I'm totally happy to hear it, but I want to explore more perspectives first.

Real quick, we have a couple of reviews. Got to read the disclaimer here. We have a few reviews from Apple podcast to read.

Under SEC regulations, we are required to disclose whether a review, which may be interpreted as a testimonial, was left by a client, whether any direct or indirect compensation was paid for the review, or whether there are any conflicts of interest related to the review. As reviews are generally anonymous, we are unable to identify if the reviewer is a client or disclose any such conflicts of interest. As we always say, we have never paid for a review and we wouldn't do that because it'd be weird. Does one of you guys want to read the first one?

Ben Wilson: Sure, I'll take the first one. "The best. This pod balances technical analysis and behavioral finance perfectly.

Enjoying going back to the beginning and listening from the start now. Thank you, Ben, Cameron, and team by ChrisK519 from Canada."

Ben Felix: It's always impressive to me when people go back to the beginning.

Ben Wilson: I hear that happen often. I've heard of a few people recently like, oh, I just found this podcast and I've gone back to the beginning to listen to everything and I've gotten through 200 episodes so far this year.

Ben Felix: That's crazy. It gets increasingly crazy as the podcast gets longer in its existence. Do you want to read the next one, Dan?

Dan Bortolotti: Yeah, this one's really brief. It just references our interview with Tom Hardin and it's a short review. It says, "riveting," by Drew Bergasser from the US of A.

That was a very fun interview to do, really interesting guy. I think a little bit of a departure from what we often do on the podcast, but my understanding is the feedback has been really positive.

Ben Felix: Yeah, people really like that episode. It's one that maybe we could have done a better job with the title. I don't know, but it didn't blow up.

That episode should have blown up. That's such a good episode. If people are listening to this and did not listen to the episode with Tom Hardin, I highly recommend going and listening to it.

It is, as you mentioned, Dan, a little bit of a departure from our typical type of content, but I think it was just fascinating. Some unique and interesting perspectives. All right.

Good to see you guys and thanks everyone for listening.

Dan Bortolotti: See you next time.

Ben Wilson: Thanks a lot. See ya.

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