Practical analysis for investment professionals
13 January 2021

Myths of Private Equity Performance: Part IV

“Perhaps what cannot be wholly understood cannot wholly be destroyed.” — Anthony Burgess, Kingdom of the Wicked

Three myths about the reliability, predictability, and resilience of private equity (PE) performance play a salient role in drawing investors to the asset class.

To prove outperformance, however, PE returns are assessed relative to those of other asset classes. From this practice, the myth of performance comparability emerges.

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Myth IV: Private Equity Performance Can Be Benchmarked

Our fascination with league tables bears some of the blame for the competition around performance reporting. Asset managers’ results are often benchmarked against those of their peers. PE managers typically report the quartile in which the investment returns of their vintage funds fall.

But it serves PE firms’ interests to make their true performance cryptic. If prospective investors can’t get a full grasp of a fund manager’s relative results, they will be susceptible to marketing tricks and branding and more prone to such behavioral biases as fear of missing out (FOMO), anchoring, and homophily, or our tendency to associate with those with whom we bear a resemblance.

In addition to performance manipulation techniques, PE fund managers have devised various strategic tools that make it difficult to analyze and assess their returns.

By building giant one-stop shops, for instance, the Big Four PE firms — Apollo, Blackstone, Carlyle, and KKR — are configuring a unique business model. Prospective investors are unable to benchmark them against the rest of the pack. They are becoming peerless, even if Ares, Bain Capital, CVC, EQT, and TPG, to name a few key challengers, are trying to keep up.

This is a risky enterprise. TPG’s field of expertise is supposedly mega buyouts, yet its track record does not always inspire confidence. My former employer Carlyle’s notable failures in the hedge fund space are hardly commensurate with the firm’s reputation. Meanwhile, EQT recently exited its credit activities business. All of which demonstrates that there are many false starts on the road to incomparability.

Individual fund managers are careful to conceal their money-making process. The investment pyrotechnics of leverage buyout (LBO) artists infuses the latter with an air of mystery derived as much from their financial innovation as from the ambiguity of their reported performance. But this theory of comparability has another side that has much broader ramifications.

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Benchmarking against Public Markets

The accumulation of surplus capital from institutional investors is an almost infinite game. Blackstone reached $500 billion in assets under management (AUM) in the first quarter of 2019. But by then, the firm had already set its sight on $1 trillion. For this reason, the Big Four are not so much in competition with their PE brethren. Rather, they aim to poach market share from other asset management sectors and morph into fully diversified private capital groups.

To attract a broader asset base and, in the process, significant fee-extraction opportunities, the leading firms emphasize their economic value creation and growth-enhancing pedigree. There’s a fatal logic to this. To appeal to this capital, PE firms have to market themselves as outperformers relative to the most visible and popular asset class: public equity.

Regrettably, PE has failed to outperform the public markets in recent years. Ample research backs this up. In a study of cash flow data from almost 300 institutional investors in more than 1,800 North American buyout and venture capital funds, Robert S. Harris, Tim Jenkinson, and Steven N. Kaplan determine that US private equity returns for post-2005 vintages were more or less equal to those of the public markets.

PE investors earned an average annual return of 15.3% for the 10 years ending in June 2019, according to Bain & Company. Over the same period, the S&P 500 generated annualized returns of 15.5% on average.

In a forthcoming study of US endowment fund performance, Richard M. Ennis, CFA, finds that none of the 43 reviewed funds outperformed the public markets over the last 11 years, but one in four underperformed. “The problem,” Ennis writes, “is the combination of extreme diversification and high cost.”

Late last year, consulting firm CEM Benchmarking added its own research into the mix to show that, net of fees, PE underperformed small-cap stock indexes in the past two decades. The researchers concluded that an in-house, lower-cost approach was the only viable investment strategy.

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Flawed Analytical Tools

These findings are stark. But they don’t tell the whole story. In my experience, the inconsistencies inherent in the analytical process render these comparison exercises futile. What is most surprising about PE industry performance data is that anyone relies on it in the first place. Returns are so easy to manipulate and misreport that it is impossible to prove their relative superiority or inferiority let alone their veracity.

The shortcomings of the internal rate of return (IRR) method are well documented. To address its deficits, Austin Long. III, and Craig J. Nickels, CFA, developed a tailor-made indicator — the public market equivalent (PME) or index comparison method (ICM). The PME reproduces private equity cash flows as if the same capital calls and distributions had occurred in the public markets. The yield is then compared to the fund’s actual IRR. If the IRR outperforms the PME, then the fund outperformed the public index.

Don’t think that, from then on, the PME became the new yardstick to measure performance and reach a definite conclusion to determine whether the illiquid asset class outperformed public equity.

Almost as soon as the PME was introduced, academics developed new metrics to supersede it. Why? Because as Warren Buffett once observed:

“The data are there and academicians have worked hard to learn the mathematical skills needed to manipulate them. Once these skills are acquired, it seems sinful not to use them, even if the usage has no utility or negative utility.”

No fewer than four subsequent versions of the PME have been introduced. Christophe Rouvinez devised PME+ to better match the net asset value (NAV) of the index investment to the NAV of the fund. After that, the modified PME (or mPME) was conceived. Then researchers proposed the direct alpha method. Among the PME’s later incarnations are the implied private premium (IPP or PME Alpha) and the alternative ICM.

Other metrics abound. There’s the cash-on-cash or money multiple, distributions to paid-in capital (DPI), residual value to paid-in capital (RVPI), and total value to paid-in capital (TVPI). The proliferation of analytical tools is a serious issue. Buffett has a point.

Perhaps the principal flaw of the research into PE performance is that the conclusions are drawn from a subset of performance data and then compared to the S&P 500, or some other benchmark, which itself reflects a sample of public stocks. Unfortunately, no data provider has access to a comprehensive list of the 5,000-plus PE firms operating worldwide. Academic research is undermined by the fact that datasets are not representative of the PE fund universe.

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The Process of Complexification

No one can definitively demonstrate that PE performance exceeds or lags behind that of the public markets. Issues of representativeness, biases, misreporting, comparability, manipulation, and persistence make such determinations all but impossible.

Of course, fund managers are all too keen to overengineer their performance reporting and assessment processes. Inevitably, these elevate their fabled track records with enough arcane opacity to frustrate any efforts by detractors to disprove them.

Using the financial equivalent of mystical incantations, fund managers will herald the benefits and quality features of their product and their ability to control and nurture portfolio assets as majority shareholders. Marketing experts also know that complexification of a technical product helps hide its deficiencies. Complexity leads to incomprehensibility.

Perhaps the most enduring and misguided notion motivating inquiries into PE performance is that investors are rational. If researchers can prove — in itself a quixotic undertaking — that PE performs no better than public markets, they imagine institutional investors will cease allocating capital to the asset class.

But as the management guru Peter Drucker once wrote:

“Of all incongruities, that between perceived and actual reality may be the most common. Producers and suppliers almost always misconceive what it is the customer actually buys.”

In other words, the PE firms’ clients — institutional investors — are not rational. They would continue to commit capital to PE even with indisputable proof that the asset class cannot consistently and persistently beat public equity. To comprehend such behavior, it is worth remembering the famous business motto from the 1980s: “Nobody ever got fired for buying IBM.”

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Takeaways for Investors

This series has revealed several key insights about private equity:

  1. PE performance is not reliable: Fund managers can manipulate and fabricate results.
  2. PE performance is not replicable: Fund managers do not consistently demonstrate unique capabilities to drive returns, which are thus neither predictable nor resilient.
  3. PE performance is not comparable: There is no consensus on the measurement techniques and standards to apply to derive returns on investment.

Prospective PE investors still eager to play the game must therefore follow a disciplined approach. This entails:

  • Diversification by allocating capital across a select and thoroughly due diligenced subset of fund managers.
  • Committing capital on a deal-by-deal basis rather than through a fund. This has two key advantages: For management fees, the clock only starts ticking when the investment takes place rather than when the capital is first committed; and investors retain full discretion on which deals to participate in.
  • Investing directly to avoid fees altogether.
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Like ghosts, witches, and elves, the superiority, resilience, and persistence of private equity performance are urban legends. Even if myth-making has enabled the sector to record a parabolic rise in the past decades, the evidence cannot be gainsaid: PE results can neither be benchmarked reliably nor delivered consistently. Which is what makes the industry’s exorbitant fees so baffling. Most fund managers still impose a generous 2/20 fee structure, or 1/20 for megafunds.

How do they get away with it? For the reasons we have shown. They work tirelessly to perpetuate a thick veil of opacity that renders their trade incomprehensible.

The rent-seeking imprint is safe. Unless change comes from within.

As he prepared to bow out of the industry in 2004, legendary LBO trailblazer Teddy Fortsmann halved the annual fees his firm Forstmann Little charged clients, slashing them from 1.5% to 0.75%. He declared at the time:

“I thought, it’s just not fair. I don’t see how we can make the kind of returns we have in the past, and as long as the returns are going to be less, probably the fees should be less.”

Seventeen years later, is it time for another reality check?

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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.

Image credit: ©Getty Images / Anders Blomqvist

About the Author(s)
Sebastien Canderle

Sebastien Canderle is a private capital advisor. He has worked as an investment executive for multiple fund managers. He is the author of several books, including The Debt Trap and The Good, the Bad and the Ugly of Private Equity. Canderle also lectures on alternative investments at business schools. He is a fellow of the Institute of Chartered Accountants in England and Wales and holds an MBA from The Wharton School.

12 thoughts on “Myths of Private Equity Performance: Part IV”

  1. Lissette says:

    I’ve learned a lot of new things on your post, thank you!

  2. Much of the content in this essay appears to be wrong or misleading. Canderle seems to have an ax to grind and is not really interested in an objective assessment of the latest empirical research related to private equity. For example, data from Burgiss we use for research is effectively comprehensive, pristine (LP cash flows to the penny to the day) and provides for easy benchmarking against any index. There are a lot of important and interesting open questions related to PE risk-adjusted returns, yet this analysis does not address any of them as far as I can tell. Feels like a perspective based on the state of the industry and analysis about 10 years ago. I don’t think readers should consider this information up to date or accurate.

    1. Sebastien Canderle says:

      Thank you for your comment, Gregory.

      I understand that, as an academic, you might be upset by some of the content and comments in this article, but my intention is simply to make everyone aware of the major issues related to PE performance studies.

      If you are implying that the Bain & Co, Richard Ennis and CEM Benchmarking data are out of date (even though they relate to performance up to 2019), I look forward to reading your more up to date information.

      Please bear in mind that, as I explained in Part I of this series, any vintage that is only a few years old reports interim (that is mostly unrealised) IRRs; therefore its performance is open to widespread manipulation. Only funds that are fully realised can be entirely trusted, although it does not prevent the use of credit lines, quick flips and divi recaps discusssed earlier.

      You claim to have fully comprehensive and pristine data straight from LPs, I look forward to reading your research. It would be the first of its kind. I clearly stated in this piece and the previous instalments that all the academic studies are based on a few hundred fund data at best, which risks making them unrepresentative. If yours is fully representative, please publish it for your peers to review.

      If you are aware of studies that include the entire population of PE firms and funds, please share it with all of us. I doubt that such a dataset is available, but I am happy to be proven wrong.

  3. Prof. Gregory Brown says:

    Comprehensive analysis of datasets is here:

    Discussion of recent performance data are here:
    (appeared in Journal of Private equity, Fall 2019, 22 (4) 11-18.)

    These and many more are in the public domain and easy to find.

    1. Sebastien Canderle says:

      Thank you George.

      Nowhere does it say in the paper you refer to ( that the four datasets reviewed are ‘comprehensive’. It would be wrong of you to suggest so.

      I note that this research paper is dated 2015, so it is older than the ones I mention in my article. Your accusation that my “perspective is based on the state of the industry and analysis about 10 years ago” is undermined by your reference to a paper that is 6 years old (and presumably the datasets are even older).

      The Journal of Private Equity’s article dated Fall 2019 is not more up to date than the three sources I mentioned earlier from Bain & Co, Richard Ennis and CEM Benchmarking. Their findings were in fact published last year (in 2020) so have every right to be called as ‘up to date’ as the Journal’s article.

      Again, I don’t see anything in the sources you provide that shows that benchmarking can be deemed reliable. You seem to believe that the data fed by LPs is unquestionable.

      Why don’t you read the first three parts of this series – a large portion of the IRRs including in your datasets are interim (unrealised) data. Hence they are not final and cannot rightly be benchmarked against public equity markets whose returns are truly ‘final’.

    2. Sebastien Canderle says:

      I also note from the two sources you gave that you are focusing on your own findings while ignoring that they are contradicted by some of your co-authors in other publications, including one I mention in this article (

      You state, as an introduction to your Journal of PE article: In a recent paper, “Demystifying Illiquid Assets – Expected Returns for Private Equity,” Ilmanen, Chandra and McQuinn (of AQR) give a perspective on the past, present, and expected future performance of private equity. They conclude that “private equity does not seem to offer as attractive a net-of-fee return edge over public market counterparts as it did 15-20 years ago from either a historical or forward-looking perspective.”

      So these researchers agree with me, and disagree with you. That could be what upsets you so much.

      The fact that your findings contradict the findings of other scholars gives even more credence to ther conclusions of this four-part series. In PE, because data are so unreliable, researchers can litterally say everything and its opposite. To repeat myself, complexity leads to incomprehensibility.

      1. Jim Vavra says:

        Great rebuttals Sebastien. If I were in legal trouble and you were a lawyer, I would want you to represent me!

        1. Sebastien Canderle says:

          Thanks Jim. Good to know I have a back-up option in case I decide to leave finance!

          In truth, often these comments are a way for academics to plug their own research. I am still getting to know the world of academia and it is the way they market their research. That way they encourage people to download and cite their papers. It is the academic-equivalent to clickbait.

          What matters most of all is to make sure university professors do not kid themselves (or their readers) in believing that their findings are reliable.

          Given that performance data in PE are incomplete, easy to manipulate or manufactured and, for recent vintages, interim, I find it slightly naive, even potentially dangerous, for scholars to claim that they are using comprehensive and pristine data.

          That is one of the reasons for this series: to debunk all those myths. The one PE proponents genuinely seem to believe in is discredited by what we call the GIGO principle: garbage in, garbage out.

  4. I think the chart in the website linked has a pretty good one stop shop to see how PE funds have performed historically using direct alpha metric and the S&P 600 index. What is missing is that direct alpha has no concept of risk adjustment which is required for fiduciary work. We know that traded firms are levered in the 30% range and PE firms in the 70% range so just that would suggest a beta of around 2 if assets had similar risk. I think a more reasonable guess is 1.3-1.5 but it is up for debate.

  5. Michael Brown, CFA says:

    Thanks so much for this review. Taking it all into consideration but allowing that some of us still have to analyze PE funds, would the Long Nickels PME be near the top of your list of where to start that work?
    Thanks, Mike

    1. Sebastien Canderle says:

      Hi Mike,

      Yes, it would be a good start, as long as you keep in mind the issues raised in this series regarding the reliability of the underlying performance data.

      In my view, the latter is where you need to spend most of your efforts.

      All the best,


  6. Anthony O. says:

    Thanks so much for this article. You mention it’s a series so I will surely read into the previous parts that led to this article, to have a fuller picture of your framework. But based on what I read so far I agree fully. Another word I like to use for Private Equity managers is obscurantists.

    If professional money managers who trade in public markets had the leeway their private equity counterparts have, I’m sure they would also post “IRR”s in the 20%+ on a yearly basis, but it’s not that easy for them, luckily for the rest of the market if I may add.

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