The devil’s in the detail

Here’s a subjective assessment of immediate prospects for private equity. 

Industry headlines and analysis of the overall prospects for the asset class often skip over the perennial issue of top quartile and top decile performance. Those performance ratios, which are already looking less and less flattering compared to performance of public markets, look even more unexceptional for funds outside the top quartile or decile. 

Some of the industry’s top names may be able to beat the S&P 500 on a consistent basis, but that’s if you can get into them in the first place. And if leverage and deal access and other performance multipliers are moving to the better quality funds, then what about the rest? It stands to reason that less well equipped and supported players are going to perform worse in a difficult market. 

Related to this is the question of access. Naturally, everyone will want to get into the top-performing top quartile or decile funds. But the fact that it’s so difficult to do so ought to be a warning sign in itself. And if access itself is a commodity, and what’s more, a commodity in a highly fragmented and opaque sector, it should scream signs of an inefficient market to any unbiased observer. That suggests all the usual vices of such markets – preferential treatment, advantages for insiders, inefficient pricing, and all kinds of potential for chicanery or simple misrepresentation. 

Then there’s the denominator effect already observed in the current turnover in secondary deals. This should emphasise that private equity’s supposedly countercyclical characteristics are way overstated. The fact that private equity limited partners use the asset class’s slow reporting schedules simply to avoid showing bad performance figures ought to worry trustees enormously.

Finally, the continuing favour shown to the asset class by probably its biggest investor group – US pension funds – signifies a market dynamic that private equity certainly isn’t responsible for, but is very complicit in: pension funds looking to it as the panacea for years of underfunding, overpromising, and less than rosy public markets returns. Private equity may not have created the problem but it’s certainly not the solution.

So, thumbnail advice for allocators in 2023 and beyond: don’t rely on private markets to fix your public markets problems. Those problems probably stem from very unrelated issues, and private market dynamics may well not be the solution. The suggestion then, is to keep on allocating, but prudently, smartly, moderately, and whilst turning a deaf ear to marketing hype.