Exposed: The Myth of Private Equity and Venture Capital Outperformance

by Larry Swedroe

Don’t believe the claims of outperformance among private equity and venture capital investors. A recent study documents the daunting odds against picking a winner in these complex alternative asset classes. Fortunately, there’s a way for advisors to gain similar exposure to potentially higher returns in low-cost passive funds.

Capital committed to private equity (PE) funds worldwide has risen substantially in the last two decades, thanks largely to U.S. pension funds searching for alternatives to public equity markets that might help them meet their return objectives. Endowments seeking to replicate the successes of the Yale Endowment have also contributed to the growth of PE funds, which obtained commitments for more than $460 billion in 2013, a twelve-fold increase over the $38 billion committed in 1995.

The term “private equity” is used to describe various types (e.g., buyout funds and venture capital funds) of privately placed (non-publicly traded) investments. Even though buyout (BO) funds and venture capital (VC) funds have a similar organizational form and compensation structure, they are distinguished by the types of investments they make and the way those investments are financed. BO funds generally acquire 100 percent of the target firm (which can be public or private) and use leverage. VC funds take minority positions in private businesses and do not use debt financing.

[drizzle]Steven Kaplan and Berk Sensoy contribute to the literature on the performance of PE funds through an extensive survey of current research on the performance of private equity. The following is a summary of the findings from their October 2014 paper, “Private Equity Performance: A Survey”:

  • Buyout funds have outperformed the S&P 500 net of fees on average by about 20 percent over the life of the fund.
  • Venture capital funds raised in the 1990s outperformed the S&P 500 while those raised in the 2000s have not.
  • Before the 2000s, buyout and venture capital fund performance showed strong evidence of persistence.
  • Since 2000, there is little evidence of buyout fund persistence (with the exception of persistence among the worst performers, those in the bottom quartile) while venture capital fund persistence has remained strong.

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Global Private Equity-Backed Buyout Deal Flow

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