Bold statement: The belief that private credit is a risk-free shortcut is exactly what blinds investors to real danger—and the warning signs are flashing louder than expected.
In this discussion from Morningstar’s The Long View, Mark Higgins, a noted author and senior VP at IFA Institutional, shares his concerns about the surging deficit, the historical performance of active management, the need for central banks to stay independent, and what financial history suggests about the US trajectory. The conversation unfolds with Christine Benz and Amy Arnott, offering a clear lens on current markets and potential pitfalls.
The cycle of asset classes chasing unrealistically high returns may end with everyday investors as the main targets
- Arnott notes that many institutions overinvested in high-fee, risky assets like hedge funds and private equity during periods of generous returns, and asks whether similar overallocations exist today.
- Higgins argues the risk is greater now, tracing a pattern that began in the early 1980s when venture capital and buyout funds benefited from falling inflation and rising valuations. Yale’s endowment, led by David Swensen, popularized the idea that private equity and hedge funds could deliver Yale-like returns. But that success stemmed from exceptional access, talent, and timing, not a universal blueprint.
- Today, trillions are allocated to these asset classes, with signals of overallocation: dwindling distributions, companies awaiting exits, and a shift from institutions to retail investors through 401(k) and defined-contribution plans. This isn’t the start of a cycle; it’s the end, and retail participants are most exposed to the fallout.
The “lack of fear” around private credit should cue investors to wake up
- Higgins identifies a pervasive sense that “free money” exists in private lending, despite a limited legitimate need for additional capital after the 2008-2009 crisis. That narrative once made sense, but the market has shifted: early, legitimate gaps gave way to herd-driven enthusiasm, driving down yields and masking risk.
- Arnott highlights the counterpoint: private credit funds may show appealing yields, but default rates are nontrivial—around the 10% mark in some readings. The First Brands bankruptcy serves as a potential wake-up call, yet many investors focus on upside while downplaying the risk side.
- Higgins maintains confidence that the cycle will break, though specifics require more time and pattern-focused analysis across institutions rather than a single data point.
Loopholes quietly inflating private markets raise red flags
- Arnott explains that the market’s “six phases of a bubble” framework can be observed across assets such as U.S. stocks, bitcoin, gold, and AI-related equities. The private markets, especially evergreen funds investing in secondaries, pose a particular concern.
- The dynamic: institutions are divesting, while evergreen funds chase secondary positions. An accounting rule from 2009, meant for reporting convenience, allows markups to NAVs in a way that can misrepresent actual performance. To sustain reported gains, funds may rely on escalating secondary purchases and larger markups, creating incentives that may not align with real-world exits or cash flows.
- Critics point to potential overpayment in bids, dubious reliance on one-day markups, and incentive structures that reward managers for markups rather than real economic value. The Wall Street Journal’s coverage of Hamilton Lane’s practices underscores the broader risk of inflated reported performance driven by accounting tricks rather than underlying fundamentals.
Bottom line for investors
- The combination of overextended private markets, a misleading narrative around private credit, and exploitative accounting practices creates a precarious landscape for retail investors entering private-market exposures through retirement accounts.
- The key takeaway is vigilance: scrutinize assumptions about risk and return, question narrative-driven optimism, and demand transparency around valuations, exit timing, and fee structures. With cycles tending to end when retail participation peaks, the prudent approach emphasizes diversification, skepticism of seemingly free gains, and a clear understanding of how reported performance relates to real-world outcomes.
What do you think? Are there specific red flags you’d look for when evaluating private credit or evergreen private-market funds in a retirement portfolio? Share your thoughts and experiences in the comments.
