You’ll notice something almost immediately when you walk into any private equity pitch meeting. The charts are stunning. Returns increase steadily. There seems to be very little volatility, that uneasy squirming that plagues investors in the public market. The entire presentation seems designed to ease anxiety, and maybe that’s the whole point. Because there is something much messier going on beneath those polished slide decks and smooth curves, and more academics and industry veterans are refusing to turn a blind eye.
The private equity sector may be sitting on hundreds of billions of dollars in unrealized losses due to assets that were held for too long, purchased at excessively high prices, and valued using techniques more in line with optimistic modeling than with market reality.
| Category | Detail |
|---|---|
| Industry | Private Equity (Alternative Asset Management) |
| Assets Under Management | ~$3.6 trillion in portfolio companies globally |
| Key Term | “Volatility Laundering” — coined by AQR’s Cliff Asness |
| Average Hold Period (2025) | 6.7 years (historical average: 5.7 years) |
| Companies Held 5+ Years | ~50% of 29,000 PE-owned companies |
| Dry Powder Ratio | 35% (vs. 92% in 2002) |
| Exit Backlog | Largest since 2005, per McKinsey |
| Valuation Method | Quarterly model-based (not real-time market pricing) |
| Key Academic Study | Mark Anson, Journal of Portfolio Management, 2024 |
| Reference Website | McKinsey Global Private Markets Report |
The method that enables this is known by a term in the industry. Cliff Asness of AQR Capital Management coined the term “volatility laundering,” and once you realize what it entails, those lovely performance charts become much less reliable.
It’s an almost disarmingly straightforward mechanism. Every second of every trading day, shares in a publicly traded company are priced by the market. The number shifts. Violently at times. That volatility is evident and real. In contrast, private equity portfolios are usually only valued once every quarter, and the valuations are generated internally and are not based on actual market transactions, but rather on models, assumptions, and management projections. An artificial smoothing effect is the end result.
Because it is rarely tested against real buyers and sellers, the portfolio appears stable. Many of these holdings might appear very different if they were priced similarly to everything else.
The Journal of Portfolio Management published Mark Anson’s 2024 study, which provided scholarly support for what many practitioners had long suspected. His research showed how private valuation techniques enable managers to effectively spread volatility over time, giving the impression that their funds have higher skill-generated returns and less systematic risk than the data actually supports.
Two results stand out: alpha is inflated, suggesting manager talent that may be mostly a measurement artifact, and beta is understated, making private equity appear less correlated to the larger market than it actually is. It is a twofold advantage based on a methodological deception.
This is especially noteworthy because private equity firms are by definition not low-risk enterprises. Compared to their public counterparts, they are typically smaller, less diversified, and significantly more leveraged. These traits ought to increase volatility rather than decrease it.
However, the stated figures consistently point to the opposite. Observing this dynamic over years of data, one gets the impression that the industry has profited greatly from investors not raising the issue of how these figures are truly generated.
Examining the EBITDA numbers that support the pricing of private equity deals reveals an even greater disparity in valuation. 94% of the 858 corporate issuers in a Fitch analysis needed their reported EBITDA to be adjusted. Researchers have found that private equity sponsors typically overstate EBITDA by about 30%, which implies that the purchase price multiples reported to investors are understated by a comparable amount.
The deals made during the low-interest-rate frenzy of 2019 through 2021 appear much less appealing when you take that into account. For businesses with private market opacity, buyers paid public market prices, occasionally higher.
The exits aren’t coming, and those deals are getting older. The industry is dealing with its biggest exit backlog since 2005, according to the most recent research from McKinsey. Globally, there are about 29,000 private equity-owned businesses valued at $3.6 trillion, half of which have been owned for five years or longer. A full year longer than the historical average, the average buyout hold period has increased to 6.7 years. Businesses that made aggressive purchases at peak valuations are now hesitant to sell at the discounts that today’s buyers are requesting. They wait as a result. The assets remain in place.
This generates a tremendous amount of quiet pressure. Compared to 92% in 2002, the ratio of dry powder, or capital available for new investments, to locked-up capital has dropped to a record low of 35%. It’s more than just a figure.
This means that the industry is limited in a way that hasn’t happened in more than 20 years in terms of its ability to raise new capital, make new agreements, and produce the kind of activity that keeps the machine running. All of this is taking place at a time when reported valuations appear to be relatively stable on paper.
It’s difficult to ignore the fact that investors with the greatest exposure to this dynamic—pension funds, university endowments, and sovereign wealth funds—also have the least freedom to raise difficult issues. Years ago, these institutions made capital commitments based on performance records that appeared better than they might have.
There is no way to pull out. When you have a future fundraising relationship with the fund manager, it is awkward to demand transparency. The structural incentives are all directed toward upholding the cozy delusion that everything is alright.
It’s highly likely that the private equity sector will endure this time. It has previously withstood challenging exit markets. However, compared to five years ago, it is now more difficult to ignore the concerns being voiced about how risk is assessed, how valuations are reported, and how EBITDA figures are created. It’s still unclear if regulators will advocate for stricter disclosure requirements or if institutional investors will become strong enough to demand them on their own.
The fact that the current system of quarterly model-based valuations, which is disconnected from actual market transactions, is providing anyone with an accurate picture of the true value of these portfolios is becoming more and more difficult to dispute. The charts appear seamless. The underlying reality appears much rougher, as it frequently does.
