Private equity returns, risk and persistence

This is another entry in the public versus private assets discussion.

The chart below shows the dispersion of returns across a range of listed and unlisted asset types. Leaving aside the fact that the private equity returns are based on the internal rates of return of the funds, which overstate the cash returns to investors a lot1, the chart clearly shows that the dispersion of returns is much higher for private assets. In investing, dispersion of returns means risk: just by looking at the chart, you can see that traditional assets’ return to risk ratio is much better.

Source: CAIS

That’s not a surprise, because listed markets allow you to diversify your capital across many investments, while private asset funds are invariably concentrated in a few names. In private equity, most of the return comes from a few winners, with the bulk of the investments in the fund having mediocre returns or losses.

The other interesting finding is that while past returns from a manager seem to have predictive power for future returns in venture capital, for the last two decades buyout private equity funds have shown little evidence of performance persistence2. That is, there’s little to support the idea that a buyout private equity manager’s fund will do well just because their previous funds have done well. This phenomenon is well known in listed markets, where competition between active managers has made markets more efficient and driven the rise of low cost index investments. From an asset allocator’s perspective, it also means that even if you believe there’s a robust private asset premium, you need several different PE funds in your portfolio to access it reliably.

  1. Much of the “internal rate of return” of private equity funds comes from early revaluations that can’t be withdrawn and reinvested, unlike listed public equities where the return really is a compound return. This makes a huge difference. The median PE buyout fund shown here has an IRR return of 13.6%. If you took that at face value, you’d expect to get a profit of $144 for every $100 invested, assuming the fund has a seven year life. In reality, the median cash profit on a PE fund is more like $60 on every $100 over the life of a fund. See Private equity returns for more. ↩︎
  2. See https://www.sciencedirect.com/science/article/pii/S092911992300010X ↩︎

Important Information: This document has been prepared by Aequitas Investment Partners ABN 92 644 165 266 (“Aequitas”, “our”, “we”), a Corporate Authorised Representative (no. 1284389) of C2 Financial Services, (Australian Financial Services Licensee no. 502171), and is for distribution within Australia to wholesale clients and financial advisers only.

This document is based on information available at the time of publishing, information which we believe is correct and any opinions, conclusions or forecasts are reasonably held or made as at the time of its compilation, but no warranty is made as to its accuracy, reliability or completeness. To the extent permitted by law, neither Aequitas nor any of its affiliates accept liability to any person for loss or damage arising from the use of the information herein.

Please note that past performance is not a reliable indicator of future performance.

General Advice Warning: This document has been prepared without taking into account your objectives, financial situation or needs, and therefore you should consider its appropriateness, having regard to your objectives, financial situation and needs. Before making any decision about whether to acquire a financial product, you should obtain and read the relevant Product Disclosure Statement (PDS) or Investor Directed Portfolio Service Guide (IDPS Guide) and consider talking to a financial adviser.

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