Recently, private market skeptics, fueled by a misleading, high-profile report from a large financial institution [State Street Private Capital Insights Q4 2024], have again suggested that the long-run performance of private equity has lagged that of public markets. This is an increasingly important topic as discussions intensify around broadening access to private markets. As policymakers weigh whether, and how, individual investors should be allowed to invest, it’s essential that we begin with a clear view of the historical facts.
It is certainly true that over the last two years the valuation marks for both venture capital and buyout funds have not kept pace as public markets have surged to record highs. Part of that lag could reflect genuine underperformance relative to comparable public companies. However, it is important to note that much of the perceived public market rally has been narrowly concentrated in a small group of mega-cap technology stocks, the Magnificent 7, leaving behind most other public and private companies alike.
More important, a large part of the recent divergence reflects the well-established fact that private market valuations (which are estimates of net asset values and not real-time market prices) lag public market valuations. This is true on both the upside and the downside. Consequently, short-run performance comparisons are largely uninformative, especially so when public markets move markedly up or down. Because of this lag in valuations, private equity has almost always underperformed public markets in years when public markets rise substantially -- and outperformed when the public markets decline.
These dynamics underscore the need for a longer-term lens. To get a meaningful read on relative performance, one needs at least a five-year history and preferably longer. Just as importantly, any serious analysis must account for the type of fund, its geographic focus, and an appropriate public market benchmark. It’s simply incorrect to compare all private funds, or even all private equity funds, to a U.S. public equity market index. Proper comparisons should match equity to equity, by geography.
Much of the debate centers on the internal rate of return as the default performance metric, despite its known distortions, particularly in settings with irregular cash flows and fund structures. To remedy this, our analysis uses the Direct Alpha, a methodology that directly compares the timing and size of private fund cash flows to those of an appropriate public market benchmark. This yields a clear and investable notion of relative performance, and one that is not susceptible to the internal rate of return’s shortcomings.
Armed with better metrics, consider the trailing 5-year period ending last December that included both ups and downs in the public markets. In this case, private equity outperformed public markets by 2.1% for U.S.-focused funds and by 2.6% for funds focused outside the U.S., despite the lagging returns of the last two years. The performance of PE relative to public markets over the last 10-years is similar in the U.S. (+2.5%) and even higher outside the U.S. (+4.1%). The 20-year track record of private equity is still better relative to public markets.
Does this mean future private equity returns will necessarily exceed those of public markets? Of course not. No one can predict the future. However, we should be clear-eyed about the past. Performance should be evaluated using sound methodology, and the facts are not in dispute. In fact, the Institute for Private Capital at the University of North Carolina recently published a publicly-available research paper offering a comprehensive look at historical, risk-adjusted returns of all major private fund types (https://go.unc.edu/RiskAdjPerf).
Further, strong historical performance does not necessarily mean that all investors should have unfettered access to private markets. Serious policy questions remain—particularly around investor protection, transparency, and access to high-quality intermediaries in a very illiquid environment. However, that is where the discussion should reside. We should no longer be debating long-settled facts about historical performance. Let’s shift the conversation to the real issues that matter.
