Practical analysis for investment professionals
09 November 2016

Private Equity’s Demise Has Been Greatly Exaggerated

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Private equity’s demise has been overreported. That’s according to me and Claudia Zeisberger, founder of INSEAD’s Global Private Equity Initiative.

Zeisberger demonstrated that private equity is very much alive, backing up her assertion with reams of data, in a presentation at the 69th CFA Institute Annual Conference. And personally, I’m tired of hearing about the rumored death of something immortal.

Critics of private equity are not hard to find, and if you listen to them long enough, you’ll hear all kinds of stories that make your stomach turn. No doubt, there have been bad actors abusing the label of “private equity investment.”

But private equity is a governance structure, not a business model or industry. As Zeisberger defines it, the format encompasses activities that go by many names — venture capital, growth equity, leveraged buyouts — the list goes on a while, depending on how retro you’d like to get with your jargon.

Despite the various challenges faced by each form of private equity investment, private companies need money now and will need it in the future. And on the other side of the equation, there can be attractive incentives for supplying capital. CalPERS CIO Ted Eliopoulos summed it up in a 2015 investment committee meeting: “Currently, private equity is the only asset class in our portfolio that is expected to exceed our seven and a half percent target rate of return on a net basis.”

Here are several reasons why there are solid opportunities within the broad private equity category:

  • Accessing the right opportunities: Investors in developed markets are used to allocating capital through liquid, well-diversified public markets. In China, India, and Japan, the top 10 firms represent 18%, 27%, and 17% of the country’s total market capitalization. In Nigeria, Peru, and Columbia, the top 10 represent 72%, 72%, and 71% of market capitalization. To access the most exciting components of a country’s economic story, an investor will need to go private.
  • Repeatable returns: Alternatives are always Rorschach Tests to some degree, and critics will suggest that private equity returns are only repeatable when capital markets provide a source of cheap leverage. But you can’t get leverage without some kind of return stream, and there is evidence that private managers add value. Citing a study on value creation from the Center for Entrepreneurial and Financial Studies and Capital Dynamics, Zeisberger noted that operational value creation accounts for almost three quarters of unlevered returns.
  • Idiosyncrasies: It can be hard to analyze investments from both a top-down and bottom-up perspective, especially when considering a massive asset class that spans the earliest to latest stages of a company’s life cycle. But remember: most private equity firms are composed of curious, hardworking people trying to do things differently from their competition. Some will succeed.

It’s not all sunshine and carried interest from here on out. The same set of concerns that apply elsewhere in investing — slowing growth, pricey assets, and intensifying competition — accompany private equity. Zeisberger noted that 96% of investors surveyed by Coller Capital saw high asset prices as a headwind for private equity prices in the coming three to five years.

Private equity firms can add value to the companies they invest in and engage with, but it won’t be easy or automatic. Despite those hurdles, 88% of investors surveyed by Prequin at the start of 2016 expected to commit the same amount of capital or more to private equity this year as they had in 2015.

Overall, the death of private equity has more in common with the long-rumored death of Abe Vigoda than an actual mortality event.

This article originally appeared on the 70th CFA Institute Annual Conference blog.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Photo courtesy of W. Scott Mitchell

About the Author(s)
Sloane Ortel

Sloane Ortel publishes The Sloane Zone, an email newsletter that comes when you least expect it and makes more sense than it should. She joined CFA Institute's staff as a sophomore at Fordham University, and was instrumental to the global growth of Enterprising Investor as a collaborator, curator, and commentator over the subsequent eight years.

4 thoughts on “Private Equity’s Demise Has Been Greatly Exaggerated”

  1. Bradford Case says:

    Thanks for focusing attention on the question, Will. Let me, though, challenge your analysis.
    The fundamental question is whether equity investments made through private (illiquid) markets provide better risk-adjusted returns than equity investments made through public (liquid) markets. Your essay doesn’t even ask that question, much less answer it. The quotation from Ted Eliopoulos, for example, says nothing about risk-adjusted returns: I can achieve net total returns of 7 1/2 percent using absolutely any asset whose returns exceed the cost of capital, simply by adding enough leverage (and therefore risk). That seems to be what private equity has “achieved” for approximately the past 20 years.
    Likewise, your comments about the largest companies’ share of public market cap in various markets are irrelevant: “the most exciting components” depends entirely on whether the BEST investments are in public or private markets, not how big the biggest public companies are.
    CEM Benchmarking, in a study of the ACTUAL investment results of more than 200 large U.S. pension funds over the 17-year period 1998-2014, found that the Sharpe ratio (risk-adjusted returns) of private equity investments was 0.32, which was exactly the same as for U.S. large-cap stocks and less than the 0.36 for U.S. small-cap stocks. And that wasn’t taking into account the additional risk of illiquidity. (The report, which my employer sponsored, is available for download at; see especially table ES5.)
    Lots of independent academic researchers have evaluated whether private equity has provided better investment results than similar investments in public equity, and they have had a very difficult time showing any advantage.
    Investors in private equity have taken on a huge amount of risk, and it’s very far from clear that they’ve been better off as a result.

    1. Will Ortel says:

      Brad —

      Many thanks for the challenge and for reading! Have got to return the favor though. I’m not really sure the question you have raised has the same level of essentiality that you do, at least within the frame I am using. I’m also not sure the evidence you’ve offered supports your conclusion.

      That’s not because I think fees or risk-adjusted returns are irrelevant — far from it! Both are a very big deal, and it’s not my intent to argue that private equity investments are always and everywhere a good idea. My point is the inverse: PE investments are not never and nowhere a good idea.

      The survey you’ve linked is interesting, but to my eye you’re somewhat using a sharpe ratio as a blunt object. To what degree does it reflect the global experience? Can we draw existential conclusions about the asset class from the experience of 200 Defined Benefit plans in the US?

      At first blush, sure. The statistics that you’ve offered are generated based on 3200 investor-years of experience. But they are specific experiences: defined benefit pension plans. There are questions about whether the entities managing these plans are fit for mission, so it’s not clear to me whether it’s more natural to draw conclusions about implementation or performance from this. Of course, issues with both exist. We could also talk about timeframe and what the world looks like if the dollar is not your reference currency.

      Definitely there are matters of opinion here, but I’d suggest a more nuanced approach in weighing the evidence I’ve offered. I think it significantly affects the rationale for private investments in some countries that liquid indices do not capture a large percentage of businesses there, for instance. The local situation in Nigeria, Peru, or Columbia may indeed be completely irrelevant to aggregate-level statistics, but for investors active in those countries it might be more important to know.

      Cheers, all the best, and thanks for reading —


  2. Brad Case says:

    Hmm…I’m not sure how to make use of your response, Will. You seem to be making the case that privately provided capital exists, and will continue to exist, whether or not supplying it is a good idea from an investment standpoint. Doubtless that’s true, but it doesn’t strike me as an interesting point; moreover, why include Ted Eliopoulos’s quotation if it’s not to suggest that investors should expect to get superior returns?
    And there’s the rub: despite lots of marketing-speak about the superiority of private equity as a way to invest, there has been precious little empirical evidence to support the idea. Do you think there is an empirical basis to support the idea that investors can EXPECT to receive higher net total returns by investing in private equity, by enough to compensate them fully for the additional risks?

    1. Will Ortel says:

      Brad —

      Sure, definitely get it and see where you’re coming from. I think this essay would be better if I had asked this question inside of it: would people still set up PE funds if they weren’t shortcuts to getting personally rich?

      I think that makes it a lot clearer. These things get a lot of reflexive dislike. Is it because they are always and everywhere bad, or because they’re considered as a implied fee structure rather than a governance structure?

      Your rub question is a good one — Is there is an empirical basis for investors in general to expect outperformance in private equity in general?

      Absolutely no way, at least not more so than in any other asset class. Investors in general should be shying away from active choices where they are not neccessary, minimizing costs, and saving more.

      But that says more about investors in general than Private Equity. Let’s talk about CalPERS. I included the quote from Ted because I think it’s significant — he thinks there’s an opportunity there, and writes more checks than I do. Theoretically it’s easier to believe that he has a shot at outperformance, but writing fewer checks would probably be a priority of some people if they were in the same seat. If you’re really big or small (less than ~50MM), it’s a funny asset class to use.

      Those fortunate enough to be in special situations though — say, successful entrepreneurs with expertise relevant to the strategy, or organizations with great networks of managers, or something — could well be very thoughtful allocators to PE funds. The probability an organization that’s special in this way hasn’t already realized it is limited in my mind though.

      Hope that clears things up! Cheers, and all the best —


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