Private Equity: Are the Benefits Worth the Cost? A Critical Analysis
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Private equity (PE) has gained significant traction over the past five years, with investors seeking high total returns, diversification, relatively low risk, and infrequent drawdowns. However, these benefits come at a cost, and investors must pay a premium fee for this asset class. This paper examines whether the diversification, lack of deep drawdowns, and overall low-risk profile of PE are illusory and whether a significant percentage of PE's return is replicable via a more cost-efficient substitute. It analyzes each of these oft-cited benefits of PE and whether “liquid private equity” strategies can play a similar role to traditional PE in investors’ portfolios. The study also evaluates generating performance similar to that of PE with a tailored portfolio of publicly traded companies. PE supporters argue that owning private companies is a diversifier to owning public companies. However, this is not necessarily true. There is a 75.7% correlation between the total returns of PE and the public equity market, which is relatively high considering that one asset class reports smoothed returns while the other does not. Furthermore, most buyers of goods and services make their purchasing decisions with little regard for whether a company is publicly listed or privately held. On the other hand, many pro-PE analyses are quick to point out the decline in the number of public companies during the first two decades of the 2000s and the meaningfully larger number of private companies than public companies.
Dissecting the Purported Benefits of Private Equity
While many investors find smoothed returns attractive, they may accept a return discount for them, as the notion of an illiquidity premium exists to provide investors with a higher return than that of comparable listed assets. The study explores whether the real questions are how much performance smoothing is worth and whether PE should still command an outsized percentage of an investor's total fee budget relative to the percentage of capital allocated to PE in that investor's portfolio. It also analyzes the feasibility of generating performance similar to that of PE with a tailored portfolio of publicly traded companies. Are you curious to know more about the study's findings on private equity's other illiquidity premium? Click "Click report" to read the full research paper.
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