Criticisms of private markets

Private markets have a reputation: fine returns, few jolts. Let's look at what lies behind these two promises.

A listed share has a price at every moment. An unlisted company does not. Nobody buys or sells it every day.

So, to say what the fund is worth, its holdings are estimated. That is valuation by expert judgement.

In other words, a price you give yourself. Often overseen by the one who is paid on performance.

Say a year when the stock market loses twenty per cent. A private fund, with similar companies, shows only minus five.

Did these companies really hold up better? Or was their price simply estimated gently?

The apparent calm often comes from there. You do not see the jolts, because the price is not measured every day.

Second criticism: illiquidity. A fund of this kind often lasts ten years, sometimes more.

Throughout that time, you cannot get out. Or only by selling your share to another investor, often at a discount.

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For the manager, it is an advantage: it never has to sell in a panic. For you, it is locked-up money.

Third criticism: fees that pile up.

The fund takes its own. If you go through a fund of funds, it adds its own. And so does the adviser who sold it to you.

Say four per cent a year in total. A return of twelve per cent before fees becomes eight per cent for you.

Over ten years, ten thousand euros become thirty-one thousand and fifty-eight before fees. Twenty-one thousand five hundred and eighty-nine after.

Nearly nine thousand five hundred euros went in fees. Almost as much as the starting stake.

Last criticism, the deepest: where does the return come from? Talent, or debt?

Back to a buyout: one hundred million, of which thirty put in by the fund and seventy borrowed.

The company gains twenty per cent in value. The fund's share goes from thirty to fifty million. Up sixty-seven per cent.

Nothing more was improved: debt multiplied the gain. And it multiplies losses the same way.

To judge talent, you must compare with listed shares carrying as much debt. And there, the gap can melt away.

None of this makes private markets bad by nature. But four questions are a must before going in.

Who sets the price? When can I get out? How many layers of fees? And how much debt behind the return?