The Gilded Age of Private Equity for the Masses

It’s easy to look at the lifestyles of the rich and famous and wonder about what it would be like to break into this world. For most of us, it’s not realistic to expect an invitation to Jeff Bezos’ wedding, a coveted reservation at the most exclusive restaurant, or a spot on the waiting list for an Hermès Birkin bag.

And if you’re on the outside looking in, it’s natural to assume that if something is exclusive and mostly available to the wealthiest echelons of society, it must be better in some way.

The asset management firms hoping to gain access to trillions of dollars in “retail” investor dollars are explicitly referencing this aura of exclusivity as a key marketing message for private equity offerings. But there are several reasons to be wary when you hear fund marketers make claims about “democratizing investing” or opening up access to areas previously only available to an elite group.

Reasons to Be Wary

For one, investing is already democratized. It’s been a long time since only the well-heeled could hope to call themselves investors. The SEC moved to eliminate fixed trading commissions back in 1975, and a huge wave of innovation has made investing in publicly traded stocks cheaper and easier ever since then. Thanks to online trading platforms, a person of modest means can easily buy shares in almost any publicly traded company in a matter of seconds. With the advent of cheap, passively managed mutual funds and exchange-traded funds, it’s also faster, cheaper, and easier than ever for investors to build a diversified portfolio.

Another issue that often gets lost in the hype surrounding private markets is that public capital markets are a good thing. Investors who buy into publicly traded stocks or bonds are getting both transparency about what they’re investing in plus a ready source of liquidity. Private capital investments, on the other hand, are often opaque and illiquid by design.

We often hear claims that private investments generate higher returns, but there has been considerable debate about this topic. For one thing, measuring performance for private equity and private debt is not straightforward. Most industry benchmarks use internal rates of return, which aren’t really comparable to traditional performance measures like total return.

A number of academic researchers, including Morningstar board member and University of Chicago professor Steve Kaplan, have delved into company-level source data to correct for this issue. (Jack Shannon’s recent article provides an excellent overview of some of the research related to this topic.) A 2020 paper by Ludovic Phalippou, “An Inconvenient Fact: Private Equity Returns & The Billionaire Factory,” is also worth reading. Phalippou argues that net of fees, returns for private equity funds have been in line with those of the public equity markets since 2006.

PitchBook, which is now part of Morningstar, has also compiled data on public market equivalent returns for private equity. Based on those metrics, performance for private equity funds with vintage years from 2020 through 2023 did not generate positive excess returns, although funds with vintage years from 2011 through 2019 fared significantly better.

An initial analysis of performance data for semiliquid interval funds lends some credence to the idea that returns may not be all that compelling. As shown in the chart below, since-inception returns for most semiliquid private equity and venture capital funds have trailed the Morningstar US Market Index.

Even if one is convinced that private capital has had a performance edge in the past, there’s no guarantee that this return advantage will continue or that the managers hired will be among the better performers. As Morningstar’s Jeff Ptak pointed out in a recent article, private equity funds typically have a wide dispersion of returns, meaning there’s often a large gap between the top and bottom performers. The returns you end up with could be wildly different from those of benchmark indexes.

And as large private equity firms increasingly tap into retail capital, the instruments available to average investors probably won’t be the cream of the crop. As investment sage Bill Bernstein eloquently stated in an interview with Christine Benz, “The first people who invested in private equity got the filet mignon and the lobster tails, and the Vanguards and Fidelities of this world are going to wind up with tuna noodle casserole.”

On the venture capital side, the idea of getting access to the next startup unicorn early in the game sounds appealing. But for every SpaceX-type moonshot, there are thousands of early-stage companies that flamed out or never took off, not to mention the additional risk of leveraged exposure to privately held companies.

Final Thoughts

When you hear claims about the virtues of open access to areas that were once off-limits, it’s worth thinking carefully about who’s really benefiting. As passively managed funds with rock-bottom expense ratios continue to gain market share, asset management firms are under pressure to find new sources of high-margin revenue. And that new source of revenue, in many cases, is you.

Granted, asset management executives may genuinely believe that adding exposure to private markets can improve investor outcomes. But the key thing to keep in mind is that just because an asset class has previously been behind the velvet rope doesn’t guarantee it will generate higher returns going forward. That’s especially true if billions of dollars in investor assets flood into private equity and private debt.

A certain amount of curiosity about the lifestyles of the rich and famous might be unavoidable. But when it comes to investing, there’s much to be said for the merits of a more frugal—albeit less exciting—approach.