A growing number of investors are warning of what they describe as “rot in private equity,” as concerns mount over funds striking circular deals that may inflate valuations without creating real economic value. The criticism highlights unease about transparency, conflicts of interest, and the long-term health of an industry that has grown rapidly over the past two decades.
Circular deals occur when private equity firms sell assets between funds they manage, or to closely connected partners, rather than to independent third parties. While such transactions are not illegal and can sometimes be justified as portfolio optimization, critics argue that they increasingly serve to mask underperformance. By moving assets within a closed ecosystem, funds may be able to mark up values, generate paper gains, or distribute capital in ways that appear successful on paper but fall short in reality.
Institutional investors, including pension funds and endowments, have begun to voice concerns that these practices distort true returns. Some say circular transactions create an illusion of liquidity in an otherwise stagnant market, particularly at a time when higher interest rates have slowed dealmaking and made exits more difficult. Instead of taking losses or holding assets longer, funds may be reshuffling ownership internally to maintain headline performance figures.
Another concern is valuation integrity. When assets are sold between related parties, questions arise about whether prices reflect genuine market demand. Without a competitive bidding process, valuations may rely heavily on internal assumptions rather than external price discovery. Investors worry this can delay necessary write-downs and shift risk quietly onto limited partners.
Governance and transparency issues also loom large. While many fund agreements allow related-party transactions, disclosure standards vary widely. Some investors argue they are not receiving sufficient detail about how prices are determined, what incentives managers have, or whether advisory boards are fully empowered to challenge deals. This lack of clarity can erode trust between fund managers and their backers.
Defenders of the practice say circular deals can make sense in certain contexts. For example, a fund nearing the end of its life may sell an asset to another vehicle better positioned to manage it long term. Proponents argue that such transactions can benefit investors by avoiding fire sales during weak market conditions. They stress that proper oversight, independent valuation, and clear disclosure are key safeguards.
However, critics counter that what began as an occasional tool risks becoming a systemic crutch. They argue that widespread reliance on circular deals reflects deeper structural issues, including aggressive fundraising, inflated entry prices, and pressure to show consistent returns regardless of market realities. In their view, these practices delay necessary corrections and could amplify losses when valuations eventually adjust.
The debate comes as private equity faces broader scrutiny over fees, performance dispersion, and its growing role in the global economy. With trillions of dollars under management, the industry’s practices have implications far beyond individual funds. Regulators, too, are paying closer attention to related-party transactions and valuation practices.
For investors, the message is increasingly clear: understanding how returns are generated matters as much as the numbers themselves. As one investor put it, performance built on circular deals may look solid in the short term, but over time, it risks exposing cracks in the foundation of private equity’s promise.
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