How Attractive Is Private Equity?

Asset managers selling private assets to everyday investors claim to have found investing’s holy grail: lower risk (or at least less volatility) and better returns. Is that true? The answer is mixed.

The first claim is fictional. Private securities’ prices only seem less variable because we don’t see them change throughout each trading day. As AQR Capital Management co-founder Cliff Asness puts it, their ostensible stability is “volatility laundering.”

And volatility and risk are not synonymous. The first refers to price fluctuations, the second to the odds of suffering permanent loss. Private assets can be opaque, speculative, distressed, highly leveraged, or all the above. They are not low risk. In fact, they are often riskier than public securities.

The second claim—that they offer better returns—is more directly testable. The theory is that they should because investors should demand higher returns in exchange for this higher risk and decreased liquidity, or the ability to buy and sell the investment almost at will. This is what the industry calls an “illiquidity premium.”

There has been a long academic debate over the existence and magnitude of such premium, whether managers can consistently capture it, and if other common investment factors can explain it. The results depend on a lot of assumptions and are fraught with data challenges. The bottom line is investors should not assume private assets will beat public ones simply because they are harder to trade. In most cases, it is a coin flip; investors need to do careful due diligence before buying in.

Comparing public and private market performance is not simple, though. Private equity and venture capital have long operated in private partnership “drawdown” vehicles with defined lifespans. The fund managers of these structures (called the “general partners”) get capital commitments from investors (or “limited partners”), but generally do not take the money upfront. Instead, the manager periodically “calls” the capital, or tells the investors to send the money, when they find opportunities. Over time, investors get their money, plus any gains, via distributions when the managers sell portfolio companies.

Private funds’ returns are thus traditionally measured on the timing of the inflows, or capital calls, and outflows, or distributions to shareholders. This money-weighted return calculation is called an internal rate of return, or IRR. The IRR is the discount rate that makes the present value of cash inflows and outflows equal to zero. It is a technical measure that has some use cases, but certainly shouldn’t be compared with actual annualized returns.

Mutual fund and ETF returns, on the other hand, are time weighted. They take your money immediately, so the return clock is always ticking. IRRs can often look better than time-weighted returns because early returns of capital can inflate the IRR, as can delayed deployment of investor capital, even if the total multiple returned was the same.

Imagine, for example, a private equity fund that paid $1 million ($500,000 each) for two companies. In this case, the fund called and invested the money immediately. After the second year, the fund sold one of the companies for $1 million. Ten years later, it sold the second company, also for $1 million. That equates to a roughly 15.1% IRR, and the private equity fund ends with a net profit of $1 million. However, $1 million invested in an ETF—say the Russell 1000 Growth—from April 2015 and April 2025 that generated a 15.1% compounded annualized return would’ve earned $3.1 million in that time.

IRRs are simply not the compounded, annualized returns everyday investors are used to, so they should be skeptical of any marketing materials that compare IRRs with the annualized return of a public benchmark.

Academics, of course, are wise to IRRs’ pitfalls and generally do not use them as their primary way of assessing private equity’s performance relative to public markets. Instead, they generally use a private market equivalent approach.

There are multiple PME approaches, but they all attempt to answer the same question: given the timing of cash flows into and out of the fund, would investors have been better off simply buying and selling a public index fund? A PME over 1 implies that the private fund beat the public benchmark and represents a cumulative (nonannualized) excess return given the timing of fund-level cash flows. This approach makes the most sense for directly comparing private fund performance with public markets as it neutralizes the timing issues with IRRs.

Still, the technique is not perfect. Unlike mutual funds, private funds do not have public reporting requirements, so an exhaustive set of private equity fund returns does not exist. Academics have looked at different data sources, but each suffers from some form of selection bias, and none of them can claim to be comprehensive.

Additionally, PME approaches are sensitive to the benchmarks chosen, the private funds’ presumed beta, or volatility relative to those benchmarks, and time frames examined. Changing any of those variables can lead to different conclusions even among studies using the same data.

Private equity returns are skewed to the right, meaning a handful of big winners pulls up the entire group’s average. The simplest sign of this is when averages are much higher than medians, as is especially the case with venture capital and, to a lesser extent, buyout funds.

Median results are not often discussed by academics or industry participants, who tend to focus on the simple and asset-weighted averages when drawing their conclusions. They have good reason for this: skewness is not a bad thing, and the magnitude of potential outperformance is an important consideration.

But medians tell an important story, too. They give insight about the overall merits of the asset class and whether investors, if dropped into a randomly selected private equity fund, have a reasonable expectation of outperformance versus the public markets.

The above table shows the median and simple average PMEs from two of the landmark studies on private equity performance. Steven Kaplan and Antoinette Schoar did the first big study on private equity fund performance using PMEs in 2005[1]. They used a dataset of voluntarily disclosed fund-level cash flows from 1980 to 2001.

This study found that buyout funds (funds which primarily buy whole business via mostly debt, and then, after making various operational and financial improvements, sell them) trailed the S&P 500 on both an equal-weighted and asset-weighted basis, while VC funds (which primarily take noncontrolling stakes in young, high-growth businesses) beat the S&P 500 on an asset-weighted basis but lagged on an equal-weighted basis. The median results, however, were below 1, suggesting that most funds failed to beat the S&P 500, with a few big winners pulling up the average results. However, the dataset used in the study has since fallen out of favor due to being self-reported data and of perceived lower quality, but it nonetheless provides a view of at least a subset of more than 1,000 funds.

Subsequent research has presented a brighter picture for private equity, though median results remained in line with public markets. In 2015 Kaplan and co-authors Robert Harris, Steven Neil, and Tim Jenkinson conducted another PME analysis of private equity funds using a different dataset[2], which arguably was more complete because it came from a recordkeeper provider for limited partners, or actual private equity fund investors. That should have avoided some of the selection bias that taints self-reported databases.

Once again, the data had a positive skew. The simple average PME was above 1 for both buyout and VC funds, and both looked better than the S&P 500 on an asset-weighted basis, so the average dollar topped the S&P 500. While the median buyout fund still saw a 1.09 PME, it was much lower than the 1.18 average, and the median VC result was below 1. Furthermore, when using more style-specific indexes, the median PME for buyout funds drops to 1.01—in line with public markets—while staying below 1 for venture capital funds.

This shows that manager selection matters. An investor cannot simply pick a manager out of a hat and expect to get a public market-beating return. Only investors who pick good managers get returns approaching the average.

In fact, as shown above, the median VC fund has not provided a PME over 1 since 1997. On the buyout side, the median PME has decreased significantly since 2000 and was below 1 in the last four vintages examined. That finding is consistent with other studies that found private equity PMEs decreased through the 2000s, as increased cash flowing into private funds stoked a bidding war for assets, increasing purchase prices and driving down returns.

Just as a few winners swell the average returns within VC portfolios, a handful of VC funds inflate mean returns of the group. It’s a defining feature of VC investing where funds invest in young, high-risk, high-reward startups. Venture capitalists hope a few big winners more than make up their many losers. Similarly, a few venture capital funds post massive gains while most generate lackluster results. Investors seeking VC exposure shouldn’t rely on just a single fund if they want to reap the potential rewards of the asset class.

While many academic studies use the S&P 500 as a proxy for the public market, there are good reasons to look at other public indexes as well. For instance, buyout funds tend to own smaller, steadier businesses than can carry a meaningful debt burden. Their portfolio companies also tend to come from relatively few sectors compared with more diversified public equity benchmarks. It would seem, then, that perhaps a sector-tilted, small-cap value index or a leveraged small-cap index would be a better comparison.

The theory has been tested. Jean-François L’Her and co-authors’ 2018 paper, “A Bottom-Up Approach to the Risk-Adjusted Performance of the Buyout Fund Market,” found “no evidence of outperformance by the US buyout fund market” after adjusting for buyout funds’ biases.[3] Ludovic Phalippou’s 2012 paper “Performance of Buyout Funds Revisited?” reported similar findings using a different dataset. Phalippou noted, “adjusting for the size premium brings the average buyout fund return in line with small cap indices and with the oldest small-cap passive mutual fund (‘DFA micro-cap’). If the benchmark is changed to small and value indices, and is leveraged up, the average buyout fund underperforms by -3.1% per annum.” Similarly, Kaplan et al.’s 2015 study calculated PMEs against a handful of benchmarks and found the median buyout fund to have 1.01 PME versus the Russell 2000 Value Index.

As shown in Table 1, the 2015 Kaplan study also looked at private equity funds versus small-cap growth stocks. It found the median PME was 0.87 compared with both the S&P 500 and Russell 2000 Growth Index. The average PME was higher than the Russell 2000 Growth, but again, that’s because a few VC funds posted outsize gains while most of the rest failed to beat the public benchmarks.

So, is it possible to find those outperforming private asset managers ahead of time? It has been well-documented that, in public markets, yesterday’s top portfolio managers rarely become tomorrow’s stars.

Early studies, like Kaplan and Schoar’s in 2005, found evidence of persistence in buyout and VC funds, but that finding has since been challenged.

The main problem is that often the performance of a firm’s previous funds are not known when it raises money for a new fund. That is because it takes years to realize gains on their investments, so investors sometimes do not even know which funds have been the proverbial winners. When controlling for interim results (such as, the returns of a previous fund known at the time the subsequent fund is being launched), Harris, et al., found that “for buyout funds raised after 2000, we find that performance persistence disappears if the LP investor uses interim performance to gauge the results of the prior fund”[4].

Still, the authors found some persistence for VC funds still existed using interim results. One explanation for this is that large VC firms reap long-lasting benefits from early success, which gives them credibility in the industry and allows them to better access the best startups (they have better “deal flow” in industry lingo) in the future. Still, that benefit, other studies have shown, appears to wane over time and reverts to the mean, albeit gradually[5].

But can the average investors even access those top VC funds? Private funds, depending on how they register with the SEC, are often limited to 100 accredited investors[6], so the typical investor’s best bet is to own a different fund that owns the VC fund.

While it’s hard to compare private and public vehicles, some of the latter, such as interval and tender offer funds, have been investing in private assets for years. They provide time-weighted returns that can be benchmarked to public equity indexes.

The results leave a lot to be desired. As shown below, of the 14 private equity-focused interval and tender offer funds launched in 2022 or earlier, 11 underperformed the S&P 500 since their inception through May 2025 or their last reported return date—a number of them by a lot.

A recent mergers-and-acquisition and IPO drought has not been kind to private equity, which needs more of both to generate cash for investors; and a lot of these strategies are still young. Yet the performance of some older funds does not seem to be any better, undermining the market conditions excuse.

The poor performance raises some questions, particularly whether the semiliquid structure of interval and tender offer funds is the best wrapper for these kinds of assets. Traditional private equity drawdown vehicles impose some discipline on the manager to eventually sell and generate a return for investors since they have defined lifespans. Semiliquid funds, which exist in perpetuity, can encourage managers to hold assets longer while collecting fees. Additionally, these funds generally have to hold some liquid assets to meet periodic investor redemptions, which can dilute returns. Finally, most of these are effectively funds of funds, and their subpar results reflect the reality that picking good, public market-beating managers is not easy.

Private equity is a form of active management, and investors should treat it as such. Private equity and VC managers still must select the right securities (whether funds or private companies), weight them appropriately, and manage risks prudently. Failure to do any of those things well can result in a bad outcome for investors.

While the range of potential outcomes is probably wider than public markets, there is no guarantee that a private equity fund will outperform a basic public equity ETF. In fact, median private fund results and actual interval and tender offer results demonstrate that there is little reason to assume a randomly selected private equity portfolio should outperform a public equity one.

For investors, like always, due diligence is critical. There is nothing magical about private companies or private assets and allocating to a private equity fund simply because it is private equity is not advisable.

[1] Kaplan, Steven Neil and Schoar, Antoinette. November 2003. “Private Equity Performance: Returns, Persistence and Capital Flows.” MIT Sloan Working Paper No. 4446-03; AFA 2004 San Diego Meetings, Available at SSRN: https://ssrn.com/abstract=473341 or http://dx.doi.org/10.2139/ssrn.473341. Note: Kaplan is a member of Morningstar’s board of directors.

[2] Harris, Robert S., Jenkinson, Tim, and Kaplan, Steven Neil. June 15, 2015. “How Do Private Equity Investments Perform compared with Public Equity?” Darden Business School Working Paper No. 2597259, Available at SSRN: https://ssrn.com/abstract=2597259

[3] L’Her, Jean-Francois, Stoyanova, Rossitsa, Shaw, Kathryn, Scott, William, and Lai, Charissa. July 1, 2016. “A Bottom-Up Approach to the Risk-Adjusted Performance of the Buyout Fund Market.” Financial Analysts Journal. Volume 72, Issue 4

[4] Harris, Robert S., Jenkinson, Tim, Kaplan, Steven Neil, and Stucke, Rüdiger. March 30, 2022. “Has Persistence Persisted in Private Equity? Evidence from Buyout and Venture Capital Funds.” Fama-Miller Working Paper, Available at SSRN: https://ssrn.com/abstract=2304808

[5] Nanda, Ramana, Sampsa, Samila, and Sorenson, Olav. July 2020. “The persistent effect of initial success: Evidence from venture capital.” Journal of Financial Economics. Volume 137, Issue 1.

[6] Per the SEC’s Section 3(c)(1) exemption; funds using the 3(c)(7) exemptions can have 2,000 qualified purchasers.