Practical Applications of An Inconvenient Fact: Private Equity Returns and the Billionaire Factory

Abstract

In An Inconvenient Fact: Private Equity Returns and the Billionaire Factory, from the December 2020 issue of The Journal of Investing, author Ludovic Phalippou (of the Saïd Business School at the University of Oxford) challenges the perception that private equity (PE) provides institutional investors with higher returns that justify its higher fees. PE is not available to the general public—and since PE investments are not continuously traded, there are no publicly available measures of PE rates of return. Therefore, PE firms use internal rate of return (IRR) as their primary advertised performance measure. However, a more appropriate measure of PE performance is based on a net present value (NPV) calculation, such as the public market equivalent (PME). Using this performance measure, Phalippou shows that US PE has produced about the same net-of-fees returns as the most common US stock indexes since 2006. Meanwhile, a small number of PE managers have become billionaires by receiving incentive fees based on absolute performance, not performance relative to any benchmark. The author questions who really benefits from PE investing, explains why pension funds and universities continue to embrace it, and offers suggestions to make PE investing more sustainable. TOPICS: Private equity, statistical methods, performance measurement