Practical Applications of Demystifying Illiquid Assets: Expected Returns for Private Equity

Abstract

Practical Applications Summary In Demystifying Illiquid Assets: Expected Returns for Private Equity from the Winter 2020 issue of The Journal of Alternative Investments, authors Antti Ilmanen, Swati Chandra, and Nicholas McQuinn (all of AQR Capital Management) analyze the risks, past performance, and expected future returns of the private equity (PE) industry. The increasing popularity of PE may come from the perception that PE outperforms publicly traded stocks while being less volatile. The authors assert that this view is flawed. Most investors gauge PE’s performance against the large-cap S&P 500 Index, but buyout funds (which make up the largest PE sector) invest in smaller, undervalued companies and use a great deal of leverage. Significantly, PE does not appear to have outperformed leveraged or value-oriented small-cap stock benchmarks, especially more recently. Also, PE’s lower volatility is an illusion, because PE does not use mark-to-market accounting to report daily fluctuations in value, while public equity does. Nevertheless, many investors believe PE will outperform public equity in the future. The authors are less optimistic, however, given the relative richening of PE versus public equity. Using a yield-based expected-return framework, they estimate that PE may outperform public equity by only about 1% per year, after fees. TOPICS:Private equity, performance measurement