As we step into 2026, there’s a prevailing optimism surrounding private markets, often seen as a beacon of opportunity. However, this confidence may be misguided. Evidence suggests that these markets are not only showing signs of being in a late-cycle phase, but they also exhibit characteristics reminiscent of conditions that have historically led to financial crises.
Three primary factors contribute significantly to this concerning scenario: the segmentation of risk, a troublingly aligned incentive structure throughout the investment ecosystem, and a widespread yet flawed belief about the nature of private markets.
Understanding these dynamics is crucial for investors who might be unaware of how fragile this environment can be.
Table of Contents:
Examining the supply chain of private markets
To grasp the implications of private market investments, one must look at the entire supply chain, which encompasses various players such as institutional allocators, consultants, fund managers, and more. Each participant can act rationally within their specific context, but when viewed collectively, their actions can exacerbate systemic risks.
The evolution of private market vehicles, including evergreen and semi-liquid funds, does not reflect true financial innovation. Instead, these developments often serve as a mechanism for holding illiquid assets, postponing necessary price evaluations, and maintaining an illusion of stability. The concern lies not with individual actors but with an entire system where incentives are so closely aligned that even minor disruptions could lead to significant repercussions.
The role of past financial crises
Throughout the past 235 years of financial history, particularly during the 2008-2009 global financial crisis (GFC), one critical lesson emerges: large-scale financial crises are seldom the result of a few malicious actors. Instead, they arise from countless individuals making incentive-driven choices within a vast, disconnected system. Each participant may perceive their actions as rational, but the cumulative effect of these decisions often escapes notice until it’s too late.
This pattern of behavior, where rationality breeds danger, has historically proven more perilous than the actions of a small number of wrongdoers. The financial upheavals of the 1810s, 1830s, 1907, 1929, and the GFC all share similar precursors, which are alarmingly evident in today’s private markets.
Key attributes of systemic crises
Understanding how speculative bubbles form can be likened to analyzing a manufacturing supply chain. Three core attributes consistently signal impending financial distress, particularly when referencing the GFC.
1. Risk segmentation
The first attribute is the segmentation of risk, which operates much like an assembly line in a factory. Each segment of this process introduces its own risk, yet no single participant possesses a comprehensive understanding of how these risks may amplify as they progress through the system. For example, during the GFC, mortgage originators relaxed their standards to boost loan production. These loans were then sold to investment banks, transformed into mortgage-backed securities, and ultimately distributed to various investors. While each party may have recognized their individual risks, the collective amplification of these risks often went unnoticed.
2. Incentive alignment
The second characteristic is a near-perfect alignment of incentives among the various players involved. During the GFC, not only did mortgage originators and investment banks share a common goal of increasing mortgage volume, but other entities, such as ratings agencies and financial media, also benefited from this growth. No key player had a compelling reason to slow down the process, creating a scenario where the entire system was set up to escalate risks.
Flawed assumptions in private markets
The third crucial element is the prevalence of a deeply rooted yet erroneous assumption regarding private markets. Often, prevailing beliefs can lead to disastrous outcomes. For instance, during different historical periods, investors have confidently assumed that asset prices would continue to rise indefinitely—an assumption that has often been proven wrong.
In private markets today, participants operate under the belief that risks are manageable and that the current trajectory will remain stable. This mindset allows them to underestimate the threats they contribute to the system. As these flawed beliefs go largely unchallenged, they provide the psychological comfort needed to ignore rising risks.
Given that all three of these characteristics are currently present in the private market landscape, caution is warranted. Participants across the supply chain are incentivized to expand operations while neglecting the importance of maintaining rigorous underwriting standards. Moreover, external influences, including trade media and academic narratives, often reinforce these dynamics, contributing to a dangerous cycle.
In conclusion, recognizing the systemic risks associated with private markets is essential for investors. By understanding the intricate interplay of incentives, risk segmentation, and flawed assumptions, one can navigate this complex environment more effectively and make informed investment decisions.
