There are times when all the world’s asleep

The questions run too deep

For such a simple man

Won’t you please, please tell me what we’ve learned?

I know it sounds absurd

Please tell me who I am —Supertramp

Until the recent spate of disappointments, private assets had delivered exceptionally strong returns. Both

private equity

(PE) and private debt (PD) funds had far outperformed their publicly traded brethren. Another perceived advantage of private investments was their relatively low volatility. Lastly, they were viewed as having low correlations to traditional stock and bond portfolios and a related capacity to diversify portfolios.

What rational investor wouldn’t want to load up on assets imbued with a trifecta of high returns, low volatility and low correlation to stocks and bonds? As this alleged free lunch became increasingly accepted, it served as a lightning rod for investors, leading to a stampede of capital into private markets. Globally, PE assets under management grew from roughly US$1.5 trillion in 2010 to more than US$4 trillion by the end 2024. The private debt market also grew at a parabolic rate, with assets under management jumping from US$250 billion in 2010 to approximately US$1.4 trillion today.

Higher returns? Don’t bet on it

It is beyond me how sophisticated endowments and

pension funds

could funnel trillions of dollars in PE and PD investments over the course of only a few years and not believe that their collective actions were fundamentally changing the market for such investments.

You cannot change the inexorable forces of supply and demand. When a small amount of money finds a previously underexplored market that is replete with attractive investment opportunities, it is relatively easy to deliver excellent returns. However, when trillions of dollars chase the same strategy, it becomes increasingly difficult to do so. As famed investor

Warren Buffett

stated, “What the wise do in the beginning, fools do in the end.”

As sure as the sun rises, the combination of too much money chasing too few opportunities has coincided with a deterioration of the performance of private versus public assets. According to Cambridge Associates, PE funds have delivered average annualized returns of 7.4 per cent over the past three years ending June 30, 2025, as compared with 19.7 per cent for the

S&P 500 index

. In similar fashion, several large PD funds have faced significant write downs and a spate of investor redemptions (which often cannot be honoured due to a lack of liquidity).

Diversification value: Always was and still is a myth

The notion that private assets are uncorrelated with their liquid, publicly traded counterparts is at best inaccurate and arguably utterly farcical.

Private assets experience the same business cycles, competitive pressures, and market forces as their public counterparts. Until recently, PE firms on average took on 100 per cent to 200 per cent debt for every dollar of equity, as compared with 50 per cent for publicly listed companies. As such, their equity should be more volatile. And yet, PE funds have consistently managed to exhibit far lower volatility than most public equity portfolios.

The magic behind private assets’ seemingly low volatility lies in their lack of regular, mark-to-market pricing. Rather, the values of private holdings are based on somewhat subjective, self-reported asset values. This practice, which has been dubbed “volatility laundering,” explains how private asset managers artificially smooth their returns. While not fraudulent, this common practice creates a misleading illusion of stability and overstates the diversification potential of private holdings.

When

Blackrock Inc.

recently marked down the value of its middle market private loan book by 19 per cent, this likely didn’t result from a very recent adverse development but one that stemmed from an issue that had been festering for a longer period.

I have little doubt that in the event of a prolonged bear market in stocks or bonds, PE and PD portfolios will experience some fairly extreme pain, thereby failing to deliver their purported diversification benefits precisely at a time when they are most needed.

Echoes of Groucho Marx

The remaining question is whether future returns on private investments will be sufficiently higher than those of their public equivalents to compensate investors for their relative opacity and lack of liquidity.

The amount of capital in the private system has grown far too large relative to the supply of attractive opportunities, dampening future return prospects. Moreover, the number of unsold PE assets stands at a two-decade high, with more than 31,000 unsold companies globally.

Furthermore, the PE industry has benefitted tremendously from nearly 40 years of declining interest rates and the related use of cheap leverage. Not only have higher rates eliminated this source of return, but higher rates also have the effect of lowering exit multiples on PE investments, which has and will continue to further dampen performance.

Another cause for concern is that the incentives facing private managers have changed. The smaller, more nimble managers of yesteryear were incentivized to deliver strong returns to maximize performance fees. In contrast, today’s behemoths are motivated to maximize assets under management. The name of the game is to raise as much money as possible, invest it as quickly as possible and begin raising money for the next fund. The objective is no longer to produce the best returns, but rather to deliver acceptable returns on the largest asset base possible. As famed investor Charlie Munger stated, “Show me the incentive and I’ll show you the outcome.”

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Comedian Groucho Marx famously quipped, “I wouldn’t want to belong to a club that would have me as a member.” Private investments are generally not available to the general public. Rather, the private asset “club” is largely restricted to wealthy individuals, family offices, institutions, endowments, and the like. Given the current state and future prospects of private markets, even if the club would have me, I wouldn’t want to be a member.

Noah Solomon is chief investment officer at Outcome Metric Asset Management LP.

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