Many of private equity's attractions are illusory
- Robin Powell
- Mar 31
- 3 min read
Private equity has grown in popularity, especially among investors looking to diversify away from public stocks. NICOLAS RABENER explains that while private equity historically showed higher returns, recent data reveals those advantages have nearly vanished.
Comparing private equity returns to public markets is tricky because of different valuation methods. However, recent research shows private equity returns have shrunk and now closely match public market performance despite higher fees and long capital lock-ups.
Volatility also appears lower in private equity due to quarterly, smoothed valuations. But when private assets are valued like public stocks daily, their volatility is often higher than the stock market’s.
1. Private equity’s historical return premium is shrinking
While private equity once outperformed public markets by around 4 percent annually, this edge has nearly disappeared in recent years.
2. Fees and capital lock-up reduce the appeal
Investors must lock their money for 7 to 10 years and pay higher management fees, making similar returns less attractive.
3. Private equity volatility is understated
Apparent low volatility results from less frequent, smoothed valuations. Daily valuation comparisons show private equity can be even more volatile than public stocks.
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TRANSCRIPT
Robin Powell: One of the most talked about asset classes in recent years has been private equity.
It’s traditionally seen as an option for institutional investors. But individual investors are increasingly getting access to it as well.
Private equity particularly appeals to those who want to avoid over-exposure to public stock markets. So is there a case for investing?
Nicolas Rabener: You had the approval of the tech bubble in 2001, at the global financial crisis in 2008. And you had the Covid 19 crisis in 2020. So from an investor perspective, it's great if you have an asset class that does look different than equities and that experienced interest in private equity. And we've seen so many inflows in the last few years.
RP: It’s sometimes suggested that private companies generate higher returns than publicly quoted stocks. But is it true?
NR: It is worth highlighting that in general, it's difficult to compare the returns of private asset classes like real estate or private equity and public market returns, because they're being calculated differently.
Now there are some data providers and one of them is Cambridge Associates investment consultancy that does provide effectively private market returns that you can compare with public market trends, and they give you 20, 30 years of data.
Now, what did you see is that private equity? Historically has achieved much higher returns than public markets. And it used to be about 400 basis points per year, which is quite attractive in terms of getting an individual return from the asset class. Having said that, over the last 4 or 5 years, that additional excess return has continued to shrink and over the last few years has been almost zero.
And the metric kind of makes you question why investors allocate to an asset class that effectively returns the same as public markets, but does require to lock up capital for 710 years and charges higher management fees.
RP: One attraction of private equity is that it appears to be less volatile than the stock market.
But, says Nicolas Rabener, that’s largely a myth.
NR: So effectively, if you look at public markets that tend to be very volatile from quarter to quarter, day to day, month to month. This does not get reflected in private equity because valuations are on a quarterly basis and they tend to be smoothened, simply because the values don't like to change valuations too dramatically. Because they look like fools.
As we said so effectively, private equity does seem to be lower, from a volatility perspective on paper. Having said that, there's no reason why you shouldn't be using public market multiples, to value protected companies on a day to day basis. And researchers have done that. And that shows if you do look at private equity companies exactly like you look at public companies, then the volatility is actually higher than the stock markets.
RP: So, however appealing it may seem, most investors are probably wise to avoid this asset class altogether.
The private equity industry can be very persuasive, but the benefits may be just too good to be true.
