Howard Marks argues that private credit's apparent low volatility during market downturns is not magic but an accounting feature. By not marking to market daily, it mimics the psychological trick of simply not looking at your public portfolio's value, creating a potentially false sense of security for investors.
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The catalyst for a private credit crisis will be publicly traded, daily NAV funds. These vehicles promise investors daily liquidity while holding assets that are completely illiquid. This mismatch creates the perfect conditions for a "run on the bank" scenario during a market downturn.
Howard Marks warns that during a downturn, private credit managers may avoid recognizing defaults by simply extending loan terms for struggling companies. This 'extend and pretend' strategy can mask underlying problems, keeping assets marked artificially high and delaying a painful reckoning for investors.
Private equity and venture capital funds create an illusion of stability by avoiding daily mark-to-market pricing. This "laundering of volatility" is a core reason companies stay private longer. It reveals a key, if artificial, benefit of private markets that new technologies like tokenization could disrupt.
Private equity giants like Blackstone, Apollo, and KKR are marking the same distressed private loan at widely different values (82, 70, and 91 cents on the dollar). This lack of a unified mark-to-market standard obscures true risk levels, echoing the opaque conditions that preceded the 2008 subprime crisis.
Historically, lower-quality credit cycles involved periods of high returns followed by giving all the gains back in a downturn. Post-GFC, the absence of a sustained recession has allowed private credit to outperform high-quality bonds by 7% annually without the typical "give it all back" phase, masking latent risks.
Private equity's low reported correlation with public markets is largely an illusion created by smoothed, infrequent valuations ("volatility laundering"). The effect is exaggerated when institutions report private asset returns with a one-quarter lag, creating "accounting diversification" instead of real risk reduction.
A consistent 2-5% of Europe's public high-yield market restructures annually. The conspicuous absence of a parallel event in private markets, which often finance similar companies, suggests that opacity and mark-to-model valuations may be concealing significant, unacknowledged credit risk in private portfolios.
Jeff Gundlach argues private credit's attractive Sharpe ratio is misleading. Assets aren't priced daily, hiding risk. When an asset is finally marked, it can go from a valuation of 100 to zero in weeks, exposing the “low volatility” as a dangerous fallacy.
While retail investors may demand daily pricing for private assets, this eliminates the "hidden benefit" of illiquidity that historically forced a long-term perspective. Constant valuation updates could encourage emotional, short-term trading, negating a core advantage of the asset class: staying the course.
Investors are drawn to PE's smooth, bond-like volatility reporting. However, the underlying assets are small, highly indebted companies, which are inherently much riskier than public equities. This mismatch between perceived risk (low) and actual risk (high) creates a major portfolio allocation error.
