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Does private equity outperform public equity?

When discussing private equity performance there is a lot of ground to cover. This post is therefore a bit longer than usual and yet not exhaustive! Still, I hope you make it to the end and find it insightful.

But, in summary and to answer the above question, in my view, and as I try to illustrate, PE does outperform public equity – especially when it comes to the 1st Quartile.


However, that answer also depends on a number of things, among them

  • Time period

  • Benchmark

  • Methodology

  • Quartile

Depending on choice of these, the answer may be a clear “Yes”, a clear “No”, or a bit more of a vague “Maybe”. And it certainly also depends on individual perspective and, to some extent, personal beliefs.

This of course ensures an unresolved, ongoing, and at times heated debate

This ambiguity, reminiscent of private equity itself, causes quite some debate among both practitioners and academics.

For the latter see for example these two papers: “An Inconvenient Fact: Private Equity Returns & The Billionaire Factory” by Professor Ludovic Phalippou of Oxford University, a noted critic of the PE industry, and “Have Private Equity Returns Really Declined?” by Professor Steven Kaplan of the University of Chicago, somewhat more of a proponent.

Both are well worth reading in full, but in summary: Prof. Phalippou finds that after fees there is no out performance to speak of. Prof. Kaplan finds there is out performance, but cautions that in the current environment performance may decline.

And thus the debate continues, here are some of my thoughts

But first, in case you missed it and in full disclosure, I am a practitioner and my day job is investing in PE funds. Or, as Prof. Phalippou would put it; I live off private equity – no offense taken, he is quite right, and, as I have said before, it’s good that someone is critical of the PE industry!

With that , let’s jump in!

Is PE losing its advantage?

This was the title of Section 3 in Bain & Co’s 2020 Global Private Equity Report, which included this figure

Figure 1: US End-to-end pooled net IRR, as of June 2019

Median private equity does not out perform

Source: Bain & Co., 2020

The conclusion practically jumps out at you, over the past decade you may as well have been invested in public equities! Or as Robert Armstrong of the FT puts it: “Private equity’s meh decade”, also well worth a read.

Bain followed up on this in their 2021 report. As could be expected, the US did not change much, but at least Europe and Asia still outperform.

Figure 2: End-to-end pooled net IRR, as of Q3 2020

US private equity out performance

Source: Bain & C0., 2021

The takeaway from Figures 1 and 2; over the past decade public equities in the US offered broadly similar returns to PE buyout funds, but with more liquidity and at less cost.

With this convergence, is investing in private equity really worth it?

According to a newer piece of research by Andrew Akers, a Senior Data Analyst with Pitchbook, yes it is.

Prompted by the on-going debate as well as research, which often overlooks how institutional investors actually approach the asset class, Mr. Acker asks: “what is the actual value of adding an allocation to private equity in a broader traditional 60/40 portfolio”? I.e. focusing on actual

investor outcomes rather than pure performance comparisons.

Mr. Acker finds that performance for portfolios with private equity are stronger than those without, even when including under performing funds.

Private equity added an average of 0.6% to annualized returns relative to the benchmark. For the best performing funds, the excess return was 0.9%, while for the worst funds, it was 0.4%.

And goes on to conclude that private equity makes a pretty significant difference.

Furthermore the convergence is unlikely to continue

This is a point that Bain & Co. also make in both their two most recent annual reports. The surge in public markets since the Global Financial Crisis benefited, among other things, from very benign monetary and tax policies helping propel US equities to historic highs.

When looking at long-term averages, this surge in equities is more of an exception and, as has been the case in prior periods of strong equity market performance, i.e. the dot-com bubble. History suggests that public markets eventually will revert to the mean, at which point we would again expect to see PE out performance also in the US.

Figure 3: 10-year annualized IRR in the US and Europe

Private euqity return convergence

Source: Bain & Co., 2020

Misquoting an American president, “It’s the 1st Quartile, Stupid”

Unlike the above discussion and much of the research and debate on PE performance, for PE investors it’s not about the median or the average. Figure 4 , even if a bit dated, shows why.

Figure 4: Rolling net IRRs, 1st Quartile PE, Median PE, and S&P 500 TR (PME)

Source: Venture Economics, US all PE as of May 2017, Preqin as of April 2017

As also evident in Figures 1 and 2, Median PE returns clearly are not worth it. All else equal, more risk, less liquidity, and about the same return as the S&P 500.

But, when looking at 1st Quartile PE returns, it is very much worth it

There is clear out performance compared to the S&P 500 across all time horizons – almost double over 10, 15, and 20-year horizons. While obviously not possible for all, someone must be 3rd and 4th quartile, this is what PE investors look for and why they invest!

Indeed one could plausibly argue that just by avoiding the bottom two quartiles, which, all else equal, is easier thank picking the top two quartiles, PE investors are generating excess returns.

As to whether an investor can do this and how possibly to do so is the topic of another post.

But, IRRs are at best misleading, and at worst simply manufactured!

Is a not incorrect critique that many would now make. And, aside from Mr. Ackers findings, which are real returns, the above does indeed focus on IRRs.

IRRs are at best flawed, see for example this piece from Institutional Investor. But, while I cannot make a good argument for the continued popularity of it, I would make the point that, as opposed to much of the debate which focuses on performance as measured by IRR, no (serious) investor picks funds based on IRRs alone – even if this seems to be a presumption of much otherwise (serious) research.

But again, and apologies for another “cliff hanger”, this is the subject of another post.


One thing is certain, not least because of fees, the performance debate continues

As much as some would like to claim PE is only about performance, it is also very much about fees. Not only are PE fees, at least compared to other asset classes, exorbitant, they are opaque and are very much part of the whole discussion as to whether PE is worth it.

I agree, so in my next couple of posts I will try to break down the fee structures.

Stay illiquid!


#privateequity #venturecapital #pecompass #StayIlliquid

Sources: Bain & Co., Financial Times, PitchBook, VentureEconomics

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