Private equity proponents argue that one of the asset class’s biggest selling points is its low volatility compared with public equities. But Verdad Advisers founder Dan Rasmussen, a longtime critic of the asset class, argues just the opposite in his new analysis of several private equity funds traded on the London Stock Exchange.
Rasmussen, with the assistance of Harvard College student Julia Grinstead, looked at 10 of the largest and most liquid private funds traded in London, a list that includes “marquee brand-name firms and even includes funds-of-funds that own diversified holdings.” They concluded that the market volatility is roughly 1.5 times the market average and that these funds are trading at a significant discount to their internally reported NAVs.
“A healthy skepticism of PE’s reported NAV and volatility is necessary to understand the true risk of these funds’ portfolios,” Rasmussen said in the report.
To arrive at the volatility number, Rasmussen looked at both the internally calculated NAVs of the funds and their share prices. “Traditional reporting by these PE funds has their NAV average at 14 percent volatility, about 0.9 times the market average of 16 percent,” Rasmussen said. “By annualizing the volatility of the stock trading price between 2014 and 2024, the market volatility is closer to 24 percent, or 1.5 times the market average.”
Rasmussen isn’t the first to suggest the volatility of PE funds is likely higher than often claimed. He noted that his estimate is close to what researchers at AQR found in 2020, when they estimated the true volatility to be between 20 percent and 25 percent. “A growing chorus of critics argues that the asset class’s volatility numbers are understated and the industry is guilty of—to quote Cliff Asness—‘volatility laundering,’” Rasmussen said.
Rasmussen’s estimate of PE funds’ true volatility is also similar to how small-cap equity indices trade. “This is unsurprising given that private equity portfolio companies tend to be low-margin leveraged micro-caps—a riskier and higher volatility exposure than, say, the S&P 500,” he explained.
The analysis also looked at the funds’ market discounts to NAV to get a better understanding of whether or not the private equity fund NAVs are accurate, another area of intense debate.
“This is also an increasingly relevant question as U.S. congresswoman Elise Stefanik is now probing whether college endowments should be allowed to use NAVs rather than, say, recent secondary market transactions, as the sole source of valuation for private assets,” he said.
The 10 London-based funds he analyzed recently traded at a 30 percent discount to NAV, compared to a 10 percent discount in 2021—the year private equity fundraising peaked.
“This is a massive gap relative to NAV that suggests quite a high degree of skepticism about reported NAVs,” he said. “Public markets appear to have grown significantly more skeptical of private equity over the last four years.”
This shift in investor sentiment appears to have been driven by “rising interest rates shifting investor preferences toward more liquid assets, coupled with growing concerns over the perceived opacity in the underlying assets of portfolios,” Rasmussen said. Investors are demanding “a higher liquidity premium, meaning a higher discount to NAV, to compensate for the elevated risk and reduced liquidity. This increased required return enhances the widening discount, pushing down the market prices of PE fund shares relative to their reported NAVs,” he added.
Rasmussen argued the critiques of private equity are important as firms like Vanguard prepare to launch publicly traded funds that include private equity assets. “Public equity markets don’t seem to buy what the private markets are selling,” he said. “This could be a problem as PE funds try to exit their massive inventories either through IPOs or partnerships with firms that have broad retail distribution.”
