Why Investors Might Be Paying the Price for Illiquidity Rather Than Earning a Premium

Private market investments have attracted significantly larger allocations from institutional portfolios and, increasingly, private wealth strategies over the past decade.

The traditional argument is straightforward: investors are compensated with an illiquidity premium for locking capital into assets that cannot be easily traded. In theory, this limitation becomes an advantage, allowing investors to earn higher returns in exchange for reduced liquidity.

However, that explanation may no longer capture the full picture. What if illiquidity and infrequent pricing are not merely drawbacks investors tolerate for additional return, but features they actively prefer? In that case, the appeal of private markets may stem not only from higher expected returns, but also from a smoother, psychologically more comfortable investment experience. Rather than receiving an illiquidity premium, investors may effectively be accepting an illiquidity discount.

Viewed this way, investors may not simply be compensated for illiquidity—they may also be paying, implicitly, for reduced visible volatility.

Private markets do not eliminate risk. The underlying businesses remain exposed to many of the same economic forces that affect comparable public companies. The appearance of smoother returns often reflects stale or infrequent pricing rather than superior management or investment skill. The key difference lies in how and when prices are discovered. Because private asset valuations rely heavily on appraisals and model-based estimates instead of continuous market trading, reported returns tend to look far less volatile than those of publicly traded equities.

This distinction is critical: smoother reported performance does not necessarily imply lower economic risk or genuinely uncorrelated returns.

Investor behaviour also changes when volatility is highly visible. Constant price movements in public markets can encourage overtrading, emotional decision-making, and poorly timed reactions, especially during periods of panic or euphoria. In contrast, infrequent valuation updates can reduce the temptation to respond to short-term noise instead of focusing on long-term fundamentals.

This dynamic may help explain why fees in private markets remain high despite increasing scale and competition. Investors may not simply be paying for access to illiquid assets, but for an investment experience that appears steadier and less volatile over time.

A useful comparison can be made between publicly traded companies such as Microsoft or Google, where prices adjust continuously in response to market sentiment, and private companies such as OpenAI or Anthropic, where valuations are updated far less frequently. The latter may appear to exhibit smoother value creation, even though the underlying risks and business dynamics remain just as complex and fast-moving.

Ultimately, private markets may represent more than simple compensation for illiquidity. They may instead embody a broader trade-off, where investors give up liquidity and price transparency in exchange for a smoother return profile and a more psychologically manageable investment journey through periods of risk and uncertainty.