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Private equity: it’s all relative
Tim Jenkinson explores the questions raised by comparing private equity returns with those of public markets.

Last year my co-authors and I updated our analysis of US buyout funds (Harris, Jenkinson, and Kaplan, Journal of Finance 2014) to include figures up to Quarter 3 2016 and to include funds on a global basis (Journal of investment Management 2016). Our study raised a number of interesting questions that we hope will help investors think more carefully about future asset allocations, and inform continuing debate about management fees, profit shares, and fund structures.  

Are buyout funds a maturing asset class?

The starting point of our analysis was a comparison of returns from buyout and venture capital funds with the public market equivalent (PME). Broadly speaking, we asked if an investor would have been better off investing in private markets, or passively investing in an index that tracked the S&P500.

We found that there were very few years (in fact, only 1994, 2007 and 2008) in which the median private equity fund performed worse than the public markets. Surprisingly, even in 2007 and 2008, which you would have thought were the worst possible years in which to be in private equity, the median performed only slightly worse than the public markets. Private equity funds managed to hold on to investments, work with them, and wait for the markets to recover.  No wonder we’re seeing so much capital flow into this sector!

However, a closer look at the figures suggests that the future may not be quite so rosy. There has been a noticeable downward trend since 2002: an eight- year losing streak in which private equity returns relative to public markets came down every year, with only a positive blip in 2009 bucking the trend. In fact, since 2006 the median returns have been broadly in line with the returns from public markets; and even the top quartile managers are now returning only about 20% more than the public markets – which is about what the median managers used to produce.

In fact, performance across funds has been compressing overall. By the end of the period, the difference in returns between the top quartile and the bottom quartile managers is only about 2.5%. In other words, if you invested with a top quartile manager you would be getting about 25% more relative to PME than if you invested with a bottom quartile manager.

It certainly feels a bit like an asset class that is maturing. As the industry has grown and more funds have been created it has become more competitive. All funds have access to similar technology, skills, and finance. As a result, returns have been converging towards public market returns.

Should you focus on measuring performance in terms of multiples?

But, you may argue, it’s not all relative: a more useful way of looking at performance might be the traditional focus on ‘multiples’ – that is, the amount of money you get back relative to what you put in.

Certainly at first glance the figures look very positive. In most years, the median fund returned around 1.5 dollars for every dollar invested. Even bottom quartile funds returned more money than had been put into them. There were some notably good years, such as 2001, 2002, and 2003, and even 2007 and 2008 look like good years in multiples terms.

However, a rising tide raises all the boats. Markets have risen significantly over this period, and this has been reflected in private equity valuations. So you can be happy about the sorts of returns you got from PE – but in fact you would have done just as well putting your money into public markets.

If you are an investor, don’t let yourself be blinded by impressive-looking multiples, but focus on the opportunity cost. Where would you put your money if you don’t give it to a PE fund? The answer to that may well be that you would put it into public markets, in which case it is worth comparing the two.

Surely there’s a better way to remunerate Private Equity managers?

Another interesting way of looking at performance is to focus on the internal rate of return (IRR). Many funds have a hurdle that the manager has to beat in order to get paid profit share – a so-called ‘carried interest rate’. Whether or not a fund is ‘in the carry’ is an important indicator.

Eight per cent is a typical though not universal hurdle. In all the years we looked at, if the hurdle was set at 8% the median fund would get carried interest payments, including in 2007 and 2008 when it underperformed public markets. So managers of median funds got a profit share payment, even though they only did as well as investing passively in the S&P 500 index. In fact, in 2003, 2004, 2008, 2009, and 2010 managers could be in the bottom quartile and still be paid profit share by their investors.

Would a relative rather than a fixed hurdle be a better way to incentivise private equity fund managers?

Is Venture Capital back in vogue?

Venture Capital was the darling of the financial world in the mid-to late-1990s, generating extraordinary returns relative to public markets.  Then after 2000 it fell off a cliff, and thus began a ‘lost decade’ in which the median fund significantly underperformed public markets. Although there were some notably successful companies in that period, for every Facebook there were a myriad other social media platforms that sank without trace and with investors’ money on board.

However, our analysis suggests that Venture Capital may be finding its way back into favour. Fund performance has been rising relative to public markets. The wide dispersion of returns is less apparent. Poorly performing managers seem to have disappeared. Multiples are also rising: for many years investors simply didn’t get their money back from investing in Venture Capital, but now the multiples are better than those of buyouts.

Some of this is to do with changes in the type of VC fund. Later stage returns have been slightly better, which explains why many VC funds are leaving early stage investing to angel investors, and moving to late stage investing.

Many institutional investors are now thinking about going back into VC, and we can also see other types of investors thinking about coming into this market in some very interesting ways, such as Corporate Venture Capitalists. Some technology companies are managing to raise multiple billion dollar rounds from private investors, to the extent that they are choosing to delay or resist ever going into public markets.

Does good performance justify illiquidity?

Investing in private equity goes hand in hand with much lower liquidity than in public markets. You are inevitably locking your money away for a fairly long period of time, in addition to incurring very high transaction costs.

If you think you are going to get much higher returns than you would in the public markets, it is easy to swallow both the illiquidity and the transaction costs. But, as our analysis shows, this is no longer guaranteed, and certainly not if you pick a lower-performing or even an average manager. It all hinges on whether you think you can pick the better managers.


Overall, our findings suggest that the days of picking a manager at random and throwing your money into private equity with a reasonable expectation of phenomenal returns are over. That is not to say that the end is nigh for the sector, but investors have to make much more balanced decisions, and weigh up where they invest and how. While private equity executives will continue to focus on multiples as an indicator of success, and doubtless cling to a fixed hurdle for carried interest payments, canny investors will do better always to think of performance in relative terms.

Tim discussed these findings in a webinar in April 2017: Is Private Equity (still) beating public markets?




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Tim Jenkinson is Professor of Finance at Saïd Business School, University of Oxford. He is also the Director of the Private Equity Institute, Oxford.