The Illiquidity Premium

The Claim and Where It Comes From

The illiquidity premium is a specific proposition, and it is worth stating precisely before examining it. It holds that an asset which cannot be sold quickly must offer a higher expected return than an otherwise identical asset which can, because investors dislike being unable to sell and must be paid to accept it. The logic is sound in the abstract. Liquidity has value; forgoing something valuable should be compensated.

The theoretical case is genuinely strong in one particular setting. An investor with a long horizon and no near-term claim on capital is, by construction, less harmed by illiquidity than an investor with monthly outgoings. If the market price of an asset embeds a discount demanded by the marginal investor who does need liquidity, the investor who does not need it collects that discount as excess return. This is a real economic mechanism, it has been formalised in the portfolio-choice literature, and it is the honest version of the argument.

The problem arises when the theoretical mechanism is used to justify an empirical claim about realised returns. Those are different statements. The first says a premium should exist under certain conditions. The second says it has existed, at a particular size, in a particular asset class, net of the fees charged to capture it. The second claim is the one investors are actually buying, and it is far weaker than the first.

The Financial Stability Board's report notes in passing that insurers and pension funds are significant investors in private credit, attracted by the illiquidity premia and long maturity of the loans, features that are typically consistent with their investment mandates. That is an accurate description of why institutions allocate. It is not evidence that the premium was earned. It is evidence that it was expected.

The distinction matters more than it might appear, because the private markets return series that investors examine when forming that expectation is not constructed the way a public market return series is constructed. Public equity returns are computed from transaction prices set by strangers who disagreed about value and settled it by trading. Private asset returns are computed from valuations produced, directly or indirectly, by the party being measured. That is not an accusation of bad faith. It is a description of the data-generating process, and it has consequences that compound over a decade.

Antti Ilmanen, Swati Chandra and Nicholas McQuinn of AQR set out the difficulty plainly in the Journal of Alternative Investments in 2019. Modelling private equity, they wrote, is not straightforward due to a lack of good quality data and artificially smooth returns. Their attempt to estimate private equity's realised and expected return edge over lower-cost public equity counterparts produced estimates that display a decreasing trend over time, a trend which they observed did not seem to have slowed institutional demand. Their conjecture as to why was that investors have a preference for the return-smoothing properties of illiquid assets in general.

That is the argument this article has to take seriously: not that the premium is fake, but that a substantial part of what is being bought is not return at all.

How Much of the Premium Is Measurement

Consider what happens mechanically when an asset is valued quarterly rather than continuously.

A listed equity portfolio reprices every second the market is open. Its measured volatility reflects every change of opinion, including the ones that reverse the following week. A private portfolio holding economically similar assets is marked four times a year, by a process that starts from origination values and adjusts for changes in credit quality, borrower performance and market conditions. Even if the marker is scrupulous, the resulting series is smoother, because it samples less often and because each mark is anchored on the previous one.

Lower measured volatility with unchanged underlying economics does two things to a portfolio calculation. It raises the apparent Sharpe ratio, because the denominator shrinks while the numerator does not. And it lowers the apparent correlation with public markets, because a series updated quarterly with a lag cannot co-move with a series updated continuously. Both effects flow directly into mean-variance optimisation, and both push the optimiser toward a larger allocation to the private asset.

Cliff Asness of AQR gave this phenomenon its name. Private equity funds are not marked to market daily, which by definition implies lower volatility. Speaking to a Morningstar podcast in 2022, he described it as a mathematical fact that he resented, and noted that the valuation of private assets usually comes with a big lag. He called the phenomenon volatility laundering, and his substantive point was not that the smoothing is dishonest but that it is desirable to investors, and therefore priced.

Mohamed El-Erian, quoted in the same account, put a number on the lag: historically, revaluations of private equity assets have tended to lag behind public markets by a minimum of six to nine months. A six to nine month lag is not a rounding error in a return series. In a period of rising markets it flatters nothing much; in a drawdown it is the difference between an investor who saw the loss and one who did not.

The consequence is uncomfortable and follows logically. If investors value smoothness for its own sake, they will bid up assets that provide it. If they bid up those assets, the expected return falls. Asness made this argument explicitly: illiquidity used to be a bug, and has become something investors are willing to pay for in the form of lower returns, because the smoothed series is easier to live with. On that reading, the sign of the illiquidity premium is not merely uncertain, it may in some periods be negative. Investors are not being paid to accept illiquidity. They are paying for the reporting properties that illiquidity provides.

That is a strong claim, made by a party with a commercial interest in public markets, and it should be discounted accordingly. But it is a claim about arithmetic rather than about character, and the arithmetic is not in dispute.

What the Official Sector Now Says About Marks

Until recently this debate ran between practitioners and academics. In 2026 it moved into official-sector financial stability reporting, which changes its status considerably.

The Financial Stability Board's May 2026 report on private credit is the most complete public account of how these assets are actually valued. Its findings are worth setting out in the FSB's own terms. Valuations are typically based on a discounted cash flow or yield analysis for performing loans, supplemented by public market proxies such as leveraged loan indices or high-yield bond markets used as benchmarks for comparable peers. They are calibrated at origination and adjusted over time. They are updated infrequently, often quarterly, which the FSB describes as possibly adequate in normal market conditions but less so under stress.

The report then addresses the incentive question directly. Perceived or actual stale valuations, it states, may create a first-mover incentive during stress events, leading investors to exit a fund before asset values are potentially marked down. And it observes that managers may have incentives to manage valuations in a way that minimises the appearance of volatility, by delaying or spreading out the impact of negative shocks. On the underlying transparency problem, its conclusion is blunt: while robust governance arrangements may help address some of these concerns, the relative opacity of private credit cannot be easily resolved.

The European Central Bank's Financial Stability Review of May 2026 carried a special feature on private credit that supplies the live evidence. Semi-liquid vehicles in the United States faced sizeable redemption requests from the beginning of 2026. Some funds met investor requests in full; others capped redemptions at a specified share of fund assets in line with contractual agreements. The ECB's framing of what this demonstrated is the important part: these outflows illustrate how a deterioration in risk sentiment can spur investors to withdraw their capital from funds offering redemptions at a regular frequency, despite their portfolio holdings being less liquid.

The ECB also documents that the ability of private credit-backed firms in the euro area to service interest payments from operating cash flows has deteriorated in recent years, a trend also observable in leveraged loan and high-yield markets but absent among firms relying on bank loans. And it flags the direction of travel that matters for individual investors: the market should be monitored closely, it says, in view of worsening credit quality and possible expansion into retail-oriented structures.

Two central banks and a global standard-setter, none of them selling anything, have now put on the record that private asset marks are infrequent, discretionary, subject to incentive, and structurally difficult to make transparent. An investor who assumed the reported volatility of their private allocation was a measurement of its risk now has authoritative reason to reconsider.

The Price of Smoothness

If part of the apparent premium is measurement, the natural question is what remains, and what it costs to collect.

Three costs sit between the theoretical premium and the investor's net outcome, and each is separately documented.

The first is fees. A private fund charging an annual management fee in the region of 1.5% to 2.5% plus a performance fee near 20% of profits consumes a substantial fraction of gross return across a ten-year life. Whatever illiquidity premium exists in the underlying asset must be large enough to survive that deduction before it reaches the investor at all. The CFA Institute's Sebastien Canderle noted in November 2025 that management and advisory fees at Blackstone exceeded performance fees in seven of the past ten fiscal years, which is a statement about how much of the industry's economics is earned from assets rather than from performance.

The second is duration risk that the investor does not choose. The lock-up in a private fund is not a fixed term; it is a minimum term that extends when exits are hard. Canderle cites an analysis by the secondaries adviser Palico of 200 private equity funds which found more than 85% failed to return investors' capital within the ten-year term. An investor who priced an illiquidity premium against a ten-year horizon and then held for thirteen has seen their annualised return fall for reasons unrelated to the asset's performance.

The third is the absence of a functioning escape route, which is the point where the theory of an illiquidity premium and the practice of private markets diverge most sharply. Canderle records that private equity secondary trading amounts to less than 5% of the primary market, and less than 1% in private credit. A secondary market that thin does not provide liquidity; it provides a price at which a distressed seller can exit, which is a different thing. Replacing a general partner, he notes, typically requires approval from 75% of investors, which is a governance threshold that is rarely reached.

Set against those three costs, what is the premium supposed to be? The honest answer from the empirical literature is that it is smaller than the marketing implies and that its size is contested. Ilmanen and colleagues found the estimated edge over public equity declining over time. Phalippou's body of work has argued for two decades that reported private equity performance overstates realised investor outcomes once fee treatment and benchmark choice are handled properly, and in July 2025 he concluded that the shift toward individual investors exposes them to high fees, opaque structures and misleading performance metrics.

The defensible summary is this. A premium probably exists in some assets, in some periods, for investors who genuinely have the horizon to collect it and the selection capability to reach the managers who deliver it. It is not a property of the asset class. It is not free. And it is not the same size as the number in the pitch deck.

The Hurdle Has Moved

Every argument above would still leave alternatives looking attractive if the alternative to them were nothing. It is not, and this is the fact that has changed most since the last cycle.

On 18 August 2026 the United States Treasury's daily par real yield curve put the ten-year real yield at 2.41%, the five-year at 2.10% and the thirty-year at 3.03%. On 2 January 2026 the ten-year real yield stood at 1.94%. Real yields have risen through the year, not fallen.

Take that seriously as a benchmark. An investor can buy an inflation-linked real return of roughly 2.4% a year for ten years, in size, with daily liquidity, no manager, no carry, no capital call schedule, no gate, no valuation discretion and no operating cost. That is the thing an illiquid asset must beat, and it must beat it after everything.

Work the arithmetic through. If the risk-free real rate is 2.4%, and an illiquid private strategy charges 2% a year plus 20% of profits, and it locks capital for a decade with a meaningful probability of extending, then the gross real return required simply to match the liquid alternative is materially above 5%. To justify the illiquidity, the operational risk and the valuation opacity, it must exceed that by a further margin that a rational investor would set at several percentage points. The strategy is not being asked to be good. It is being asked to be substantially better than the best free lunch on the menu.

The second benchmark is the liquid risk asset. The UBS Global Investment Returns Yearbook 2026, compiled by Paul Marsh and Mike Staunton of London Business School with Elroy Dimson of Cambridge from 126 years of data across 35 markets, reports that equities delivered 6.6% a year in real terms between 1900 and 2025, against 1.6% for bonds, and that since 1900 equities have outperformed bonds, bills and inflation in every country with a continuous investment history. An investor can buy that exposure globally for around ten basis points a year with no lock-up.

This is where the illiquidity premium argument is genuinely tested. It is not enough for a private strategy to have beaten cash. It must have beaten a cheap global equity index, over the same period, after its own fees, with the investor's capital locked. The measured dispersion across managers means that some have, comfortably, and that the median has not by nearly the margin the category claims.

In 2021, when the real risk-free rate was negative, this comparison was easy to win and easy to avoid making. Neither is true in August 2026. Any allocator presented with an illiquid proposition this year who does not run it against 2.41% and against 6.6% is not doing the work.

What Survives the Argument

Something does survive, and it is narrower and more specific than a premium on illiquidity as such.

What survives is a premium on contracted cash flow that arrives while the investor waits. The reason is not that cash flow produces a higher return; it is that cash flow is information. A distribution paid in cash from an operating asset cannot be smoothed, cannot be delayed by a valuation committee, and cannot be modelled. It either arrives or it does not. Every problem the Financial Stability Board identifies with private asset valuation, the quarterly cadence, the discretion, the anchoring on origination values, the incentive to spread the impact of negative shocks, applies to a mark and does not apply to a bank transfer. An investor holding an asset that distributes has a monitoring instrument that an investor holding a mark does not.

What also survives is the horizon argument, in its honest form. An investor who genuinely does not need the capital for a decade is a different investor from one who believes they do not. The premium, where it exists, accrues to the first. The second discovers under stress that they were the marginal seller the theory said would be paying it.

What does not survive is the general claim. Illiquidity is not a factor an allocator can harvest. It is a cost that a specific asset, with a specific operator, in a specific structure, may or may not compensate. The unit of analysis is the deal and the manager, not the asset class, and the dispersion documented in the literature is precisely a measurement of how much that distinction matters.

Applied to any operating real asset, this translates into a short set of questions. Where does the cash come from, physically. Is it contracted or projected. Who bears the operating cost base and on what terms. How often is the asset valued, by whom, and against what comparables. What is the fee, in cash, across the full expected life. What happens if the hold extends beyond plan, which the Palico evidence suggests is the base case rather than the exception.

HelmShare's structure is one attempt to answer those questions in a form that can be examined, and it is offered as an example rather than as a conclusion. HelmShare Prime Fund, L.P. is a Cayman Islands exempted limited partnership issuing limited partnership interests. Its general partner and investment manager is HelmShare LLC, regulated by the Dubai Financial Services Authority in the DIFC as a Category 3C firm. Interests are offered under Regulation S outside the United States to professional, qualified and high net worth investors in the EU and EEA, the United Kingdom and the Gulf, and US persons are excluded. The fleet is operated at scale by Navigare under a contractual 8% yield commitment given to the Fund. That commitment runs to the Fund, not to any individual investor. Returns are targeted rather than assured, and capital is at risk.

The conclusion of the argument is not that private markets should be avoided. It is that the illiquidity premium is a hypothesis rather than a feature, that a material part of its apparent size is an artefact of how these assets are measured, and that in a world of 2.41% real risk-free yields the bar an illiquid asset must clear is higher than it has been at any point in the working lives of most people currently allocating capital. An investor who accepts illiquidity should be able to say precisely what they are being paid for it. Most cannot.