If I told someone with even a little investing experience that I own an asset that pays like stocks but is stable like bonds, they would probably think I was a huckster or a fool. Yet many of the most sophisticated investors claim to own such a thing.
I’m referring to private assets, a broad group that includes stakes in companies, loans to businesses and physical commodities, which are often the biggest holding in pension and university endowment portfolios. The allure of private assets isn’t necessarily superior performance relative to comparable investments in public markets. Rather, it’s that, because they don’t trade on volatile public markets, portfolio managers can pretend that their private investments don’t fluctuate much in value — and that any changes are mostly to the upside.
Until now. Some of the biggest university endowments in the US, including Harvard, Yale and Princeton, are looking to trim their private equity investments, partly to generate cash in preparation for the Trump administration’s funding cuts. In the process, it is becoming evident that their private equity investments are worth less than they claim. Billionaire investor and Harvard alumnus Bill Ackman has gone so far as to suggest that the university’s $53 billion endowment is worth closer to $40 billion because the value of its private assets is overstated.
With elite universities’ private equity investments on the auction block, the big reveal is coming. The discounts Yale and Harvard will probably be forced to accept will reflect in part a private equity industry that has been sluggish for years, where deals are down, distributions to investors have slowed and higher interest rates have raised the cost of financing, all resulting in lower valuations. University endowments should have already addressed the likely negative impact of that slowdown on the value of their investments. But without a public market to dictate prices, it’s easy to ignore signs that their bets may have soured.
They may no longer have that luxury. US and international accounting standards require private assets to be reported at “fair value,” which generally means the amount that would be received if the investment were sold today. If Harvard and other endowments take a haircut on some of their private equity investments, their auditors will take a close look at the rest to see if they need to be marked down as well. That could have a bigger impact on their finances than they are admitting. It should also call into question the value of private assets held by other institutional investors.
To understand how they got into this pickle, you have to know a bit about the game institutional investors are playing. Their portfolio managers are typically graded on their ability to maximize returns relative to risk, where the measure of risk is volatility. Managers can’t do much to meaningfully improve the return of a broadly diversified portfolio. But they can reduce volatility considerably — and thereby boost their risk-adjusted returns — by stuffing their portfolios with private assets that purportedly don’t fluctuate in value.
The difference in volatility between public and private equity is significant. Consider the Bloomberg Private Capital Index, an equally weighted collection of hundreds of US private equity funds across multiple strategies. It has returned 9.4% a year since inception in 2007 through 2024 with annualized standard deviation — a common measure of volatility — of 7.2%. Meanwhile, the S&P 500 Index achieved a total return of 10.5% a year over the same time but with more than double the volatility of 16.8%. On a risk-adjusted basis, private equity wins easily.
Private debt is an even bigger bonanza, where investors routinely report stock-like returns with cash-like volatility. Cliffwater Corporate Lending Fund, for instance, a popular private credit fund with $29 billion in assets, has returned 9.6% a year since its inception in 2019 through May, with a standard deviation of just 1.8%. For volatility that low in public markets, investors would have had to own Treasury bills and accept a measly 2.6% a year over the same time.
Using private assets to inflate risk-adjusted returns is an obvious fudge, though, because volatility is a poor proxy for risk when it comes to private investments. No one seriously believes that private equity, which is often an investment in startups and highly levered small companies, is less risky than the S&P 500. Or that private debt, which loans money to those same private equity companies, is as safe as T-bills. It’s more likely that a higher return signals greater risk, an economic reality obscured by private assets’ artificially low volatility.
One way to see the risk lurking in private assets is by using a wonky statistical tool well known to institutional portfolio managers called kurtosis. It indicates the extent to which an investment has “fat tails,” or the propensity for extreme outcomes. A kurtosis greater than 3 is a warning that swings in the value of an investment may be more severe than those implied by its volatility.
From 2007 to 2024, the S&P 500’s quarterly returns showed a kurtosis of 1, meaning that investors pretty much got what they expected. The private capital index, by contrast, had a kurtosis of 7, signaling that investors lulled by its muted volatility were in for a nasty surprise. Indeed, the index was down 23% around the 2008 financial crisis, a decline more severe than its volatility suggested. The Cliffwater fund’s kurtosis was 14 from 2019 through May based on monthly returns.
The mismeasurement of risk around private assets affects more than just a few universities. Pensions, charities and colleges with big stakes in private investments are taking more risk than their constituents realize or might agree with. More broadly, incentivizing institutional money managers to favor private assets distorts the balance of investment between private and public markets, which helps explain why the number of US stocks is shrinking while private equity has expanded its reach.
One way to better assess the risk of private assets is to require private funds above a certain size to make financial disclosures similar to those required of public companies. That would allow independent analysts to regularly value private funds the way they do stocks, giving investors both current estimates of what their assets are worth and additional data points with which to calculate more realistic volatility.
In the meantime, institutions could require managers to use public market proxies for the volatility of private assets. The risk-adjusted return of a buyout fund might be calculated using the volatility of small-cap stocks with comparable leverage. If risk-adjusted returns of private investments were more realistic, managers would be more likely to choose between public and private investments based on merit rather than optics.
So far, institutional investors’ big bet on private assets hasn’t received much scrutiny because the industry has been propelled by a nearly uninterrupted, decades-long expansion. But if recent headwinds persist and more institutions unwind their private investments, it’s easy to imagine a longer slowdown that leads to even lower prices, leaving pensions and endowments wondering why they aren’t as well funded as they thought.
It’s not safe to assume that any investment is a golden road to higher returns with less risk, a reality that investors in private assets will eventually have to accept — and it may start with an act as unremarkable as a few elite universities dumping some private equity.
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