The Power of Illiquidity

I. Introduction: Why Illiquidity Matters

For most investors, liquidity feels safe. The ability to buy and sell assets at will is seen as control—an essential feature of sound portfolio construction. But liquidity, while helpful in moderation, can become a source of destruction when paired with volatility, uncertainty, and reactive behavior. This report makes a bold but data-supported claim: illiquidity is not a risk to avoid, but a premium to embrace.

Liquidity serves the illusion of optionality. But during market crises, it becomes a liability. Public market assets—equities, bonds, ETFs—are subject to real-time repricing, driven not just by fundamentals but by sentiment, headlines, and herd behavior. In contrast, illiquid assets—private equity, venture capital, real estate—move at a different pace. They are insulated by design from daily volatility, allowing value creation to unfold over years, not quarters.

This report explores how public and private markets behave in periods of macroeconomic stress. We assess the sensitivity of each market to interest rates and uncertainty, evaluate the impact of volatility on wealth accumulation, and build the case for long-term allocations to illiquid assets.

II. Macroeconomic Environment and Fiscal Outlook

1. A Decade Defined by Instability

The post-pandemic decade has been marked by macroeconomic dislocations. Following the sharp contraction of GDP in early 2020 and its historic rebound, growth has become erratic and uneven. Fiscal and monetary supports have faded, while inflationary forces, supply chain recalibrations, and geopolitical shifts have altered the economic landscape.

Growth data from 1Q21 to early 2025 reflects this inconsistency—while occasional bursts of recovery appeared, the broader trajectory points to stagnation. Recent quarters show GDP barely holding above zero, raising fears of a hard landing or prolonged malaise.

2. Inflation Pressures and Monetary Policy Response

Pandemic-era stimulus programs and global supply constraints triggered the most acute inflation surge in four decades. Headline CPI peaked around 9% YoY in mid-2022, with core inflation proving far more persistent. The Federal Reserve responded with the fastest rate hike cycle in recent memory.

Despite some easing in energy prices, core inflation remains above target. This has created a policy trap—rates must stay high, even as growth weakens. Market volatility has become the norm, not the exception.

3. Interest Rates and Policy Volatility

The yield curve inversion—an historic predictor of recession—has lingered, signaling deteriorating confidence in long-term growth. The spread between short-term and long-term rates suggests policy misalignment and uncertainty about future direction.

Rate volatility has fed directly into asset market instability. Public equities and long-duration bonds have suffered drawdowns, while credit spreads remain elevated. Meanwhile, investors have rotated defensively—into cash, gold, and alternatives—as trust in market consistency falters.

III. How Does Volatility Look in Public Markets?

Sudden Stops and the Liquidity Trap

One of the most visible demonstrations of liquidity's hidden danger is the sudden stop phenomenon—particularly evident in emerging markets and global ETFs. During periods of heightened uncertainty, capital exits rapidly from liquid assets.

Events like the 2008 Financial Crisis, the 2013 Taper Tantrum, the 2015 China selloff, and the 2020 COVID shock all caused billions in capital to exit public markets within days. Losses often exceeded $30–$35 billion in under 90 days. The faster the markets move, the more panic accelerates volatility.

Private capital flows, on the other hand, remained relatively stable. Illiquidity acted as a cushion. Without daily pricing, long-term commitments stayed intact. The forced-selling dynamic that plagues public markets was largely absent.

Liquidity may enable short-term flexibility—but it also allows panic. Illiquidity, in contrast, is the natural governor of reactive decisions.

IV. Comparing Public vs. Private Markets: Volatility, Sensitivity, and Wealth Preservation

1. How Public and Private Markets React to Interest Rates

Interest rate changes have immediate impacts on asset valuations—especially in public equities, where duration risk and future earnings projections are sensitive to the discount rate.

Regression analysis reveals:

• NASDAQ Composite Index sensitivity to long-term rates is -0.4785

• NASDAQ 100 Index is even more sensitive at -0.5706

• PE Middle Market transactions, by contrast, exhibit a far milder sensitivity of -0.2307

The visual scatterplots illustrate how public markets reprice sharply as yields rise, while private market deal values show only a muted response. This insulation is structural: private equity operates on multi-year strategies, negotiated valuations, and operational improvements—not algorithmic sentiment shifts.

2. How Public and Private Markets React to Economic Uncertainty

Periods of heightened economic uncertainty deliver real-time stress tests to markets. The behavior of asset classes in these times reveals how structure dictates resilience.

This updated chart compares the volatility (Average annual standard deviation) of public vs private markets, relative to the level of Economic Uncertainty. It reinforces the argument—public indices (NASDAQ 100, NASDAQ Composite) spike in volatility when uncertainty rises, while private equity remains stable, protecting wealth from panic. PE middle-market and MSCI PE series barely budge in 2020–2022 despite historic uncertainty.

This long-cycle view of the Equity Market-related Economic Uncertainty Index (2006–2024) uses the Hodrick-Prescott filter to extract cyclical movements. The peaks—2008, 2011, 2020—coincide with public equity emotional bear/bull runs with no strong math behind. Each spike represents market hesitation, policy ambiguity, and amplified volatility.

Public assets are caught in the wave. Private assets, locked in for years, float above it.

Periods of heightened economic uncertainty are consistently associated with elevated financial market volatility, particularly in public equities. This section examines how uncertainty shocks propagate through asset classes by comparing their annualized volatility responses to fluctuations in the Equity Market-related Economic Uncertainty Index. The chart above captures the cyclical behavior of macro uncertainty from 2006 through 2024. Spikes typically coincide with major macroeconomic shocks: the 2008 global financial crisis, the 2011 debt ceiling standoff, the 2018 trade war, and the 2020 COVID-19 pandemic. These periods mark the onset of intense repricing and behavioral shifts across financial markets.

Critically, each upward spike in the index reflects not just higher volatility, but wider forecast error, increased investor hesitancy, and sharper swings in capital allocation, particularly within liquid instruments.

V. Illiquidity Pays a Premium

1. Cumulative Growth Across Market Types

From a base of 100 in 2007, MSCI Total Developed Private Equity grew to 2,970 by 2024—nearly 3x the NASDAQ 100 (983), and 11x the S&P 500 (267). This compounding gap emerges over time, not through timing.

While public markets remain vulnerable to shocks, private markets build value steadily—protected by lock-up structures, multi-year strategies, and patient capital.

2. Annualized and Total Return Comparison

Private equity dominates in both categories:

• Total Growth: 2,869.6% (MSCI PE) vs. 882.5% (NASDAQ 100) and 267.5% (S&P500)

• CAGR: 22.1% vs. 14.4% and 8.0% respectively

This outperformance is not accidental—it is compensation for illiquidity, operational execution, and time-locked alignment. It is also free from daily mark-to-market volatility.

3. Holding Periods Reveal the Secret

Private equity requires patience. Median holding periods in Europe now approach 5.7 years in 2025—up from under 4.5 in 2011. This duration enables:

• Turnaround of underperforming assets

• Operational value creation

• Exit timing based on conditions, not compulsion

If you can’t hold an asset for 5–7 years, you cannot access private market returns. This long-term commitment—seen as a disadvantage by some—is in fact the gateway to alpha.

VI. Conclusion: Illiquidity Is Not a Bug. It’s the Feature.

The prevailing narrative celebrates liquidity. But as this report demonstrates, liquidity is a double-edged sword. It enables flexibility—but it also permits overreaction, panic selling, and wealth destruction. In public markets, daily repricing invites volatility. In private markets, long-term alignment creates insulation.

Illiquidity pays a premium. It rewards commitment. It filters out noise. It gives investment teams time to execute, transform, and exit from strength. It is the antidote to the behavioral traps that ruin public portfolios.

This is why ultra-high-net-worth investors and institutions allocate heavily to private equity. They know:

• Wealth compounds in silence, not speed.

• Access to capital is less valuable than the execution of a long-term strategy.

• Long-duration, cash-flowing, appreciating assets build net worth beyond $5M, $25M, or even $250M.

For those building generational wealth, illiquidity is not an obstacle. It is the foundation.

Key Takeaways:

• Illiquidity removes the option to panic, and that builds wealth.

• Long holding periods, combined with operational execution, beat passive indexing over time.

If you’re serious about compounding, you must embrace the power of illiquidity.

Sources & References

Baker, Scott R., Bloom, Nick and Davis, Steven J., Economic Policy Uncertainty Index for United States [USEPUINDXD], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/USEPUINDXD, August 27, 2025.

Baker, Scott R., Bloom, Nick and Davis, Stephen J., Equity Market-related Economic Uncertainty Index [WLEMUINDXD], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/WLEMUINDXD, June 4, 2025.

Board of Governors of the Federal Reserve System (US), Federal Funds Effective Rate [DFF], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DFF, June 4, 2025.

Board of Governors of the Federal Reserve System (US), Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis [DGS10], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DGS10, June 4, 2025.

MSCI. (2025). Tracking Private Equity. https://www.msci.com/downloads/web/msci-com/research-and-insights/paper/tracking-private-equity/Tracking%20Private%20Equity.pdf 

NASDAQ OMX Group, NASDAQ 100 Index [NASDAQ100], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/NASDAQ100  June 4, 2025.

NASDAQ OMX Group, NASDAQ Composite Index [NASDAQCOM], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/NASDAQCOM, June 4, 2025.

PE150. (2025). Moody’s Downgrades U.S. Credit Rating Over Fiscal Risk and Inflation. https://www.pe150.com/p/moody-s-downgrades-u-s-credit-rating-amid-rising-fiscal-concerns-1830 

PE150. (2025). The State of Private Equity Middle-Market in US. https://www.pe150.com/p/the-state-of-private-equity-middle-market-in-us 

Pitchbook. (2024). US PE Middle Market Report. https://files.pitchbook.com/website/files/pdf/2024_Annual_US_PE_Middle_Market_Report.pdf