Memo 9: When Sophisticated Portfolios Fail Quietly
Editor’s note: This holiday memo is the final piece in a three-part Harvesting Alpha series on capital allocation.
The first two memos explored the risks of early-stage technology investing and the role of venture capital, private equity and private credit across a lifecycle of capital. This final piece looks at what actually goes wrong in the real world, not dramatically, but quietly, through issues of correlation, illiquidity, and timing.
It is written deliberately for the start of the year, when there is finally space to reflect of what and where to invest in 2026 and beyond.
A familiar conversation with business owners
Many of the investors we speak with are successful business owners. They can often generate returns equal to, or better than, those available elsewhere by reinvesting in their own businesses. These are enterprises they understand intimately, can influence directly, and in many cases control. The logic is compelling. Until it isn’t.
When wealth is concentrated in a single operating business (and when personal property is frequently pledged in support of that business) a single point of failure emerges. If the business falters, quickly or slowly, what remains? And how accessible is it?
This is the point at which diversification becomes relevant: not as a return-maximising exercise, but as a question of resilience. The issue is not whether reinvesting in one’s own business is rational. It is whether everything else in the portfolio depends on that business continuing to perform.
So what does diversification look like
The balance sheet of a typical investor we come across, who has begun to diversify typically looks something like this:
The family home.
An operating business or senior professional career.
One or more investment properties.
Listed shares.
Compulsory superannuation, usually invested across a mix of shares, property, private equity and credit.
Some more sophisticated investors will also hold direct exposures to venture capital or private equity funds. A smaller group again will have allocations to private credit.
On the surface, this appears diversified. Assets, structures, vehicles, managers. Boxes ticked.
Why this portfolio is less diversified than it appears
The problem is not the assets themselves. It is the drivers underneath them. In many Australian portfolios, several exposures ultimately depend on the same set of conditions:
A healthy domestic economy
Stable employment and consumer demand
Readily available credit
Functioning property and capital markets
Residential property, operating businesses, and even yield-oriented equity strategies all rely, in different ways, on these same foundations. When conditions deteriorate, correlations rise, not because prices move together instantly, but because liquidity and confidence deteriorate together.
Illiquidity: the quiet amplifier
Illiquidity is not inherently a flaw. Many private assets reward patience. The risk emerges when multiple illiquid assets depend on being realised at the same time.
Private equity and venture capital are particularly exposed to this dynamic. Exit timing matters. When IPO markets weaken and strategic buyers retreat, assets may remain sound, but capital remains trapped.
This is not theoretical. In 2024, distributions from private equity funds fell to historically low levels as higher interest rates, slower deal activity and constrained exit markets delayed cash returns to investors. [1][2]
Private equity is suffering a liquidity crisis at the moment, and it’s an asset class has that has matured. Competition for high‑quality businesses is intense, entry valuations are fuller, and excess returns increasingly depend on leverage and execution rather than obvious mispricing. In lower interest‑rate environments, this model proved resilient. In higher‑rate regimes, its margin for error narrows.
Rising interest rates have altered the mechanics of private equity returns. Debt is more expensive, refinancing risk has increased, and the tailwinds of multiple expansion have weakened. At the same time, exit markets, particularly IPOs, have become more selective. Businesses that might previously have exited now remain private for longer, while strategic buyers and other sponsors face similar constraints.
The result was not widespread losses, but something subtler. Capital that cannot be redeployed when needed. This is how sophisticated portfolios fail quietly.
When:
Venture exits slow
Private equity exits delay
Public markets become volatile
Credit conditions tighten
Assets that appeared independent suddenly become more correlated.
The consequences are familiar but often underappreciated:
Missed opportunities
Forced rebalancing elsewhere
Over-reliance on the few liquid assets left
Behavioural pressure at exactly the wrong time
There are no blow-ups. No headlines. Just a slow erosion of optionality.
Where private credit fits
This is where private credit plays a different role and often valuable role.
Private credit should not be thought of primarily as a geographic diversifier or a return enhancer. Its value lies in its cash-flow behaviour.
Unlike appreciation-dependent assets, private credit returns are driven by contractual income, amortisation and principal repayment. Value is realised through time, not at a single exit event.
This introduces duration control. Even where loans are illiquid in a trading sense, they are liquidity-generating over time.
In periods when exits are delayed and volatility rises, private credit continues to return capital. It does not eliminate risk, but it materially reduces the probability that everything fails at once.
A quieter form of resilience
None of this implies that private credit is superior to other asset classes, or that Australian investors should abandon growth assets or seek diversification offshore in markets or assets they don’t understand. The lesson is structural, not geographic.
Portfolios fail quietly when too many assets depend on favourable conditions persisting, and when liquidity arrives later than expected. Private credit introduces a counterweight, not through complexity or novelty, but through predictable cash flow.
In difficult environments, that quiet reliability often matters more than optimisation. Private credit can provide that.
¹ The Economist (2024), *Private equity’s cash problem*.
² Bain & Company (2024), *Global Private Equity Report*.