Correcting the Record – Private Equity Has Outperformed for Pension Funds and Other Investors

Professor Ludovic Phalippou recently released an incomplete, misleading article regarding the private equity industry. The facts clearly show that private equity has consistently outperformed public equity markets across market cycles–delivering hundreds of billions of dollars in net gains to millions of pensioners, non-profits, charitable endowments, and many other investors. As the AIC Public Pension study reported in 2019, private equity continues to lead all asset classes in long-term investment performance, with private equity’s median 10-year annualized net return of 10.2 percent surpassing public equity’s 8.5 percent.


Fact 1: Private equity returns have continued to outperform public markets

Research from a wide range of academics and organizations confirms that private equity investments regularly deliver higher returns than returns in the public stock market during both bull and bear markets, including for recent fund vintages.

  • Phalippou’s article ignores other research that demonstrates private equity outperformance and highlights the flaws in his methodology. Private equity investments continue to outperform public markets. In fact, Phalippou fails to reference a 2019 paper by Professors Steven Kaplan and Gregory Brown. Kaplan and Brown that found “U.S. buyouts have historically outperformed the S&P 500 by a fairly wide margin.” They observe that other studies showing recent convergence in performance between private equity and public markets in the wake of the Global Financial Crisis (GFC) was likely driven “by the immature nature of those vintages.” (Private equity funds tend to increase substantially in performance near the end of their life given the so-called “J-curve” effect.)  With the benefit of additional time and data, they found that those more recent vintages exhibited “quite healthy performance and in line with expectations of returns that are 2 percent to 3 percent above public markets.”
    • Similarly, a recent 2020 Cliffwater study of state pension performance from fiscal years 2001-2019 finds the private equity investments produced a net annualized return of 9.6 percent compared to 5.6 percent annualized return from the public equity benchmark. They further found “no evidence” for the “narrative” that “private equity returns are failing to deliver the excess return over public equity compared to years past.” Additionally, a 2018 study from Georgetown University found that Target Date Funds with a conservative private equity allocation can raise retirement income by 6 percent and by 13 percent with a moderate private equity allocation across the life of a retirement portfolio.
  • S&P 500 not representative of investors’ public equity portfolio or private equity investments. The S&P 500 is heavily overweighted toward US FAANGM tech stocks (Facebook, Microsoft, Alphabet, Amazon, Apple, Netflix representing around ~20 percent of the index), which drives a considerable part of the index’s performance. This is not representative of a typical private equity portfolio or the public equity portfolio of most institutional investors. Generally, such portfolios are much more diversified across sectors and geographies, which is why many academics, investors, and commentators believe the MSCI World Index is a more appropriate benchmark. Indeed, most of the largest private equity funds make globally diversified investments, not solely in North America as Phallipou incorrectly assumes. And even Phalippou’s flawed findings show consistent, significant outperformance from private equity compared to the MSCI World index.
  • Outperformance by mega funds. A recent McKinsey report established that “mega” PE funds–particularly relevant given Phalippou’s focus on the large end of the market have “on average delivered the highest returns over the past decade.” The report also found that these high performing funds have demonstrated an exceptional record in delivering top returns to their investors over the past 20 years.
  • Cherrypicking time period. Phalippou uses the 2006 vintage–one of the lowest-performing in recent history–as his starting point. This creates concerns that he is trying to gerrymander a particular result in his analysis. Even according to his own methodology, other periods show clear private equity outperformance.

Fact 2: As investors face declining opportunities in the public markets, private equity allows investors to diversify their portfolios–and reduce risk

  • The number of publicly traded companies has decreased significantly in the last four decades, and the amount of listed companies in the US has dropped nearly 50 percent since 1996. Capital formation is increasingly coming from the private markets so it is wise for limited partners to diversify their portfolios and gain exposure to more markets. To get exposure to companies that could provide outsize returns, pension funds must invest in companies beyond the public markets.
  • According to recent research from Hamilton Lane and JPMorgan Asset Management, private equity manages downside risk far better than do investments in the public markets. The analysis found that the risk of catastrophic loss (a decrease of 70 percent or more in value) in a public equity investment is 40 percent during a recession compared to just 2.8 percent for a buyout fund.

Fact 3: Private equity investors are highly satisfied with performance and disclosure

  • False portrayal of pension investors. Phalippou’s paper claims that public pension officials, even though well advised by consultants and premier law firms, do not get the full picture of performance from the PE funds in which they invest. This claim is patently false. Even worse, he implies that public pension officials are seeking to deceive their beneficiaries and boards about this performance – which is both false and deeply offensive.
  • Overwhelming satisfaction from investors who are increasing their private equity allocations. Limited partners are highly sophisticated investors who would not continue to allocate to this asset class if they did not believe that it was delivering outperformance relative to their public equity investment options. A 2020 Preqin report found that 87 percent of investors believed that their private equity investments met or exceeded their expectations. Additionally, 86 percent intend to allocate as much or more than they currently do to their private equity portfolios.
  • Extensive disclosure to investors. Private equity firms are highly transparent with their investors, providing a wide range of data including individual IRRs, MOICs, recent performance (of both funds and individual investments) and realizations. They also provide bespoke analysis and data upon request from their limited partners. While the inception-to-date IRRs for many private equity funds are highly impressive, limited partners rely on multiple return measures for allocation decisions.
  • Article overstates fees charged. Carried interest is only paid once a funds meets a preferred return net of all fees and expenses. This hurdle requirement results in a lower carry percentage than 20 percent of gross gain assumed by the author. Many other large limited partners also receive substantial discounts on management fees (including fee holidays at the beginning of funds and size discounts), which further reduce fees.