A recent Financial Times opinion piece laid out how illiquidity makes private equity hazardous for investors. The Bank of England’s Nathanaël Benjamin warns private equity illiquidity is a systemic risk to the financial system. The investment research firm Markov Processes International says it threatens the solvency of Ivy League university endowments. Public pension watchdog Equable Institute worries that valuation lags caused by private equity illiquidity lead to chronic underfunding.
People usually grow anxious when asset classes that are supposed to be liquid — Treasuries, money market funds, large-cap stocks, commercial paper, major commodity futures — freeze up. Investors counting on these assets for cash might be unable to make payments, leading to cascading failures and confusion. But since private equity is known to be illiquid, how can there be negative surprises? In fact, the whole point of private equity is to remove the short-term pressure of generating earnings, allowing a company’s managers to focus on creating long-term value.