The Long Arithmetic: Issue 12

There is a line on your statement that looks calm, and if you hold private things, you have probably learned to trust it. A fund, a building, a stake in a company that does not trade. The value shows up in small, well-behaved steps, a little up this quarter, a little up the next. Beside your public holdings, which lurch around all day, the private line looks like the steady one. So it earns a reputation. Low volatility. A diversifier. The grown-up part of the portfolio.

Some of that reputation is fair. Private assets can carry a real illiquidity premium, the extra return you are paid for tying your money up, and a few are genuinely less tethered to the public market's mood. That part is true, and worth keeping.

But most of the smoothness has little to do with any of that. Most of it is a measurement artifact. Think of the kind of photograph where a river turns to glass, a mountain stream shot at dusk, every ripple ironed into a surface you could almost walk across. It looks serene, and it is a trick. The photographer held the shutter open for a few seconds, and the camera averaged all that motion into one smooth blur. The water keeps moving the whole time. The long exposure is what goes still.

A private valuation works the same way. The value gets measured once a quarter, sometimes once a year, so all the movement in between is averaged into one calm-looking step. The asset was never that smooth. The infrequent picture is.

This is what I see: a smooth mark can hide two things at once, how much risk you are carrying, and how much of a good result was luck rather than judgment. Here is how each one hides, and how to look past it.

When you own a public stock, the market remarks it every second the exchange is open. You watch it move, you feel the turbulence, because you are shown the turbulence. A private holding gets marked maybe once a quarter, sometimes once a year, often by someone with a reason to keep it smooth. The value moved the whole time. You were just not shown it moving.

Cliff Asness has a name for this. He co-founded AQR Capital Management, one of the larger quantitative investment firms, and he says blunt things about his own industry. He calls the effect volatility laundering. A holding marked four times a year reports far less bumpiness than a public one marked continuously, and the smoothness is an artifact of the calendar, not the asset. "We all know the prices are moving," he has said. "You're just not observing them." Not marking something does not make it low risk.

You saw this recently. When public stocks and listed real estate fell hard in 2022, many private real estate marks barely moved at first. The bigger write-downs came through 2023, well after the public repricing. Same storm, two very different looking rides, mostly because one book was priced every day and the other on a calendar. That lag is the shutter staying open a beat too long.

The smoothness then gets read as safety. A holding with small quarterly wiggles looks like a diversifier, something that zigs when your stocks zag. Asness's point is that some of that is cosmetic: the two may be moving together the whole time, and one is just kind enough not to say so.

I spent a couple of years reviewing these deals from the sponsor's side, reading the marks and the memos before they went out. The quarterly number was almost always the calmest one in the room. Nothing about that calm was a lie. It was a photograph taken on a slow schedule.

There is a second thing the calm hides, quieter than the first.

When you do not need the money, the illiquidity feels free. The building sits there, the fund sends its letters, you are not selling, so the lock never chafes. And because it never chafes, you start to read the calm as proof you chose well. This is where luck does its best work, wearing judgment's coat.

A reader put it to me better than I could have: the good outcome and the bad outcome can be the same position held in two different years.

We are generous narrators of our own holds. The year the exit comes, we call it conviction. The year it stalls, we call it bad luck, or we call it nothing at all, because no one marked it and no one made us look.

I can give you my own. A few years back I put money into a fund converting old office buildings into apartments. The thesis was sound and the operators were good. For a while the evidence agreed: they bought well and sold a few of the assets cleanly before 2023, which felt like proof. Then the macro turned. Rates climbed, office values fell, the financing the whole model depended on dried up, and what was left of the position was gone by 2025. The operators did not get worse at their jobs between the deals that worked and the ones that buried it. The years did. Run a cycle earlier, the same fund might have made me look shrewd. Run when it ran, it made me look reckless. The position was identical, and for a long stretch the early wins let me file the timing under skill.

I wrote a few weeks ago about the forced seller, who has to sell an illiquid thing at the worst possible moment. This is the opposite problem, and the sneakier one. It hides while you are not selling at all. Nothing forces your hand, so nothing tests whether the calm was real.

So what does an honest look involve. This is how I evaluate it, for what that is worth.

One move is to unsmooth the number in your head. Picture the holding remarked as often as a public stock, every day, by a stranger with no stake in how it looks. Does your sense of its risk change when you imagine it moving that often? If it does, some of the calm you felt was the shutter speed, not the asset.

Another is the luck test, the one my fund taught me. Would you still call last year's result skill if the same position had landed in a worse year? If not, you drew a good outcome from a wide range, which is a separate fact from being right.

The last is the correlation check. When your public book fell hard last time, did this holding actually hold its ground, or did it just not get repriced until the storm had passed? Real diversification holds its ground while the rest falls. A slow shutter just has not repriced yet. Telling those two apart is most of the work.

A smooth statement is telling you something true and something misleading in the same line. The number is probably real. The calm is mostly about how often you looked, and how little you have needed to look. The turbulence you cannot see is still turbulence, and the year you finally need the money tends to be the year you learn how much of it there was.

That is where I want to turn the letter around this week. It has been about three months since the first issue of The Long Arithmetic went out, and I would rather know than guess whether it is doing for you what I hope. So this week I am asking you to answer a few questions instead of leaving you with one. Four of them, about a minute. The last two have room to write, and those written answers are the ones that decide what I write next.

The three-months in: four quick questions:

Disclaimer: This is not financial advice. Consult your CPA or licensed advisor before acting on anything specific to your situation.

Until Monday.

Alina