For decades, private equity has been one of the most enduring and popular alternative asset classes.
Part of this popularity is surely driven by a perception of high returns and significant alpha across the PE space. That excitement about PE returns was once justified, but a careful look at returns data over the last 10 years suggests that, on average across all funds, PE alpha has largely disappeared. For investors, this leads to two important questions; where did all the alpha go, and do some funds still deliver the goods?
The questions are becoming even more important as the PE space is becoming more democratized. The largest PE funds are now publicly traded, and even the rarified world of venture capital is now open to the mass affluent through new vehicles like the ones offered by SeekingAlpha.
While exact data is hard to get in the PE world, there are a number of studies that have looked at the issue. Yale did a study of buyout PE returns between 1987 and 1998 and found returns of 36% annually versus 17% for the S&P 500. To generate that level of returns, PE funds had to take on significant leverage, but that performance is still impressive. On a beta-adjusted basis, economists have found that PE generated alpha of about 5.5% between 1980 and 2006, based on buyout firm investments having a beta of around 2 and VC fund betas of around 3.
All of the alpha disappeared after 2006. While PE funds have outperformed the market as a whole by roughly 3% over a 30 year period, that superior performance is entirely driven by the early part of the sample. Since 2006, PE returns have been roughly on par with those of the S&P – all without the liquidity, transparency, or low fees of public equity markets. The chart below illustrates this.
David Swensen, chief investment officer of the Yale Endowment perhaps best summed up the challenge concluding “Investors in buyout partnerships received miserable risk-adjusted returns over the past two decades....MOREHT: Alpha Ideas