Private Equity Investing , What You Need to Know

Every investment trend seems to follow the same pattern.

A genuinely good idea emerges. It works well. Money flows in. The industry pumps millions into marketing the strategy as the new silver bullet. Managers take on more risk to keep pace with the new flow of investors and eventually the risks begin to show and investors are harmed.

We’ve seen this cycle play out repeatedly in financial markets.

In the mid-2000s, investors were told emerging markets were the future of global growth This was followed by a long stretch of disappointing returns once the strategy became widely adopted.

Around the same time, the “commodities Supercycle” was heavily promoted. Investors were told rapid global growth would lead to permanently higher prices for oil, metals, and agricultural products. Commodity funds attracted massive inflows—right before prices collapsed following the financial crisis.

After the 2008 market crash, new “solutions” quickly emerged to take advantage of wounded investor. Low-volatility and minimum-variance funds were marketed as a way to capture stock market returns with less risk. These strategies attracted enormous demand from investors seeking stability, only to struggle when rising interest rates exposed the concentration in defensive sectors.

In each case, the underlying idea wasn’t necessarily flawed. But once a strategy becomes heavily marketed and capital floods in, the expected returns often decline while risks quietly build beneath the surface.

And more recently, we may be seeing the same pattern again in private equity, private credit, and certain real estate funds.

These strategies were originally designed for large institutional investors with very long investment horizons. But over the past decade they’ve increasingly been marketed to individual investors as a way to access higher returns with lower volatility.

The pitch is compelling.

One of the biggest selling points of private investments is their smoother performance compared to public markets. But the reason for this stability is often misunderstood. Unlike publicly traded stocks, private investments are typically valued monthly or quarterly based on internal estimates or appraisals rather than by the second market prices. That means valuations in private equity move much less frequently, which can make the investment appear far less volatile.

Research from Dimensional Fund Advisors has shown that when adjustments are made for this valuation smoothing, private equity returns move much more similarly to public markets than investors might assume.

In other words, the lower volatility is often a reporting artifact rather than a reflection of lower risk.

But markets don’t work that way.

There is no return potential without risk.

The Illusion of Smooth Returns

One of the biggest selling points of private investments is their smoother performance compared to public markets. But the reason for this stability is often misunderstood.

Unlike publicly traded stocks, private investments are typically valued monthly or quarterly based on internal estimates or appraisals rather than by the second market prices. That means valuations in private equity move much less frequently, which can make the investment appear far less volatile.

Research from Dimensional Fund Advisors has shown that when adjustments are made for this valuation smoothing, private equity returns move much more similarly to public markets than investors might assume. In other words, the lower volatility is often a reporting artifact rather than a reflection of lower risk.

When the Tide Turns

The challenge with illiquid investments isn’t always obvious when markets are rising.But when investors start asking for their money back, the true nature of the assets becomes clear.

A recent example occurred in Canada when investors in certain real estate funds discovered that liquidity could disappear quickly when many investors attempt to redeem at once. Some funds have restricted withdrawals as redemption requests exceeded available liquidity (Wealth Professional - Investors Learn The Hard Way) and (Nicola Wealth to Limit Redemptions)

The problem is structural.

Real estate buildings, private companies, and private loans cannot be sold overnight. So when a fund promises liquidity while holding illiquid assets, it creates what financial professionals call an asset–liability mismatch. The assets cannot be converted to cash quickly, but the fund may still have obligations to investors requesting withdrawals

A Reality Check for Private Markets

Private equity has also begun facing headwinds as exit opportunities slow and deal markets weaken. As Ben Carlson recently noted, private equity firms are sitting on a growing backlog of unsold companies while IPO and acquisition markets remain subdued (Ben Carlson - Why is Private Equity Crashing).

This creates a challenge for funds that depend on selling companies in order to generate liquidity and return capital to investors. When those exits slow down, the entire system begins to tighten

A Growing Concern for Individual Investors

One trend that has caught my attention recently is seeing is firms with large allocations to proprietary private investments in portfolios of investors approaching retirement.

In some cases, investors planning to retire within only a few years hold meaningful allocations to private equity or other illiquid strategies. I’ve met with prospective clients with 30% of their entire portfolio invested in firm run private equity portfolio!!!

The appeal to the client is understandable:

• Strong historical returns
• Lower reported volatility (we know now the volatility is hidden)
• Access to “institutional” investment opportunities

But when valuations are based on manager estimates and liquidity is limited, the risk profile of the portfolio can be very different than it appears.

When markets change and investors need access to their capital, that’s often when the true value of the investment becomes clear.

There Is No Free Lunch in Markets

The idea that an investment can offer higher returns with lower risk is extremely appealing. But that is not how markets actually work. If an investment strategy appears to deliver stronger returns with less volatility, it’s worth asking a simple question: Where is the risk hiding? Because high returns aren’t free.

In private markets, the answer is often found in some combination of:

• Illiquidity
• Leverage
• Valuation smoothing

None of these are inherently bad. But they do mean the investment behaves very differently than many investors are being told.

The Bigger Lesson

Many financial innovations start with a genuinely good idea.

Private equity helped companies grow. Real estate funds opened access to property markets. Private credit expanded lending opportunities beyond traditional banks.

But history shows that when too much capital flows into a strategy, the industry often pushes the idea beyond its limits.

And when that happens, investors are reminded of one of the most fundamental truths in finance:

Higher returns always come with higher risk.

There is no way around it.

A Reminder About Simplicity

Private equity, private credit, and real estate funds can play a role in portfolios. But for most investors, particularly those approaching retirement, liquidity and transparency matter more. Public markets offer:

• Daily pricing
• Immediate liquidity
• Broad diversification
• Lower costs

That combination is often far more valuable than access to a complex strategy that appears sophisticated but carry hidden risks you might not fully understand.

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This information has been prepared by Brandt Butt who is an Investment Advisor and Portfolio Manager for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor and Portfolio Manager can open accounts only in the provinces in which they are registered.

iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Canadian Investment Regulatory Organization. iA Private Wealth is a trademark and a business name under which iA Private Wealth Inc. operates.

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