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.

Public pensions may invest in private assets not only for potential outperformance but to avoid the daily mark-to-market volatility of public markets. This 'volatility washing' creates an illusion of stability that may not reflect the true economic risks of the underlying assets, serving as a poor reason to invest.

Cliff Asness coined the term "volatility laundering" to describe how private equity masks its true risk. The strategy is fundamentally levered equity, which is highly volatile. By not marking to market daily, firms smooth returns and report low volatility—an accounting fiction, not an economic reality.

In private markets, there's a perverse incentive for both private equity owners and private credit lenders to avoid marking down asset values. This "mark to make-believe" system keeps valuations artificially high, hiding underlying financial stress and delaying the recognition of losses.

The absence of daily pricing in private credit removes an essential discipline. Mark-to-market in public markets acts as an honest, early warning system that forces managers to scrutinize underperforming assets, a mechanism private lenders lack.

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.

Historically, investors demanded an "illiquidity premium" to compensate for the bug of being unable to sell. Now, firms market illiquidity as a feature that enforces discipline. In markets, you pay for features and get paid for bugs, implying this shift will lead to lower future returns for private assets.

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.

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.