The crazy math confronting everyday investors in private markets

Both types of investment vehicles are becoming increasingly available to individual investors as more funds register with regulators and disclose their books publicly. Many are structured much like mutual funds, but with far less liquidity and fewer chances for investors to pull out.

The turbulence is most visible in private credit where funds lend to middle-market companies. While these funds have long pitched themselves as stable alternatives to stocks and bonds, investors are now flooding many of them with requests to cash in their shares.

This has forced managers like Blue Owl Capital to curb redemptions and lock up investors’ money. That, in turn, has led to sharp falls in the shares of publicly traded managers that specialize in such alternative assets.

But while credit funds are making headlines, private equity is the far bigger asset class, with much larger companies. Questions also persist about the valuations in those funds, even if they haven’t become as acute as those facing private credit.

Private-equity funds, for example, have ample opportunities to book large gains with subjective valuations and hold them in place for years. Unlike a debt-focused fund, where the upside is capped, a private-equity manager can manufacture home-run performance on paper by marking up ownership stakes in closely held companies or other private-equity funds.

A case in point: On Dec. 31, 2025, StepStone Private Markets recorded a 15% gain on a group of 34 investments it bought the same day for about $164 million. The maneuver instantly lifted the fund’s performance.

Its biggest gain in dollar terms involved a stake in another private-equity fund, called Odyssey Investment Partners Fund VI, which it marked up by 34%. This is common when private-equity funds buy stakes in other funds on the secondary market.

The markups may reflect bargain hunting, buying stakes at a discount to a fund’s official net asset value. But they also defy the conventional notion that an asset is only worth what someone else is willing to pay for it. The problem arises when certain valuations look too good to be true, undermining the credibility of others.

Like their counterparts in private credit, private-equity funds are supposed to mark their assets at fair market value each quarter. These assets usually lack market quotes and are difficult to value.

This opens the door for managers to rely on subjective pricing models. And when they invest in other funds, the accounting rules let them simply adopt the net asset values, or NAVs, provided by other fund managers.

That is how the StepStone fund was able to record its same-day markups. On Dec. 31, 2023, a different fund, StepStone Private Venture and Growth Fund, paid $538,100 for a stake in a venture-capital fund called CNK Fund IV and that same day marked it up 16-fold to $8.7 million.

The paper gains can lead to sizable fees. StepStone Private Venture, for instance, reported $424.4 million in net unrealized gains for the six months ended Sept. 30. During that period, it accrued $60.7 million in incentive fees, despite recording just $1.4 million in net realized gains.

The private-equity vehicles available for everyday investors are tiny compared with the trillions of dollars managed for large institutions such as pensions and university endowments. These investors tie up their money in PE funds for much longer and lack frequent redemption windows.

The California Public Employees’ Retirement System last year said $103 billion, or 15%, of its investment portfolio was in private equity. It valued those holdings using the NAVs from other managers. Calpers said its PE investments earned a 14.3% return in fiscal 2025. But when the valuations are this squishy, it’s hard to know if the returns really mean much.

In private credit, by comparison, there are no home runs to offset a bad loan. A lender’s priority is simply to be repaid. Because these funds are often leveraged, a tiny drop in asset value is amplified when it hits a fund’s equity cushion. Recent concerns have centered on artificial intelligence’s potential to disrupt software companies that have borrowed heavily from private-credit funds.

Many management teams are quick to embrace fair-value accounting when it results in large, unrealized gains. They tend to be less enthusiastic when they must recognize big losses.

The trouble with valuations that are difficult and subjective is they often stay that way long after investors have seen enough. Today it’s private credit in the spotlight. Private equity could be next.

Write to Jonathan Weil at jonathan.weil@wsj.com