Why investors should be wary of private equity for the masses

"For most people, it's natural to assume that if something is exclusive to the wealthiest echelons of society, it must be better. Asset management firms looking to access trillions of "retail" investor dollars explicitly reference this exclusivity when marketing private equity offerings. But investors should be wary when fund marketers talk about "democratizing investing" or opening access to areas previously only available to the elite."

"Investing is already democratized. The SEC eliminated fixed trading commissions in 1975, and innovation has made investing in publicly traded stocks cheaper and easier ever since. Online trading platforms allow people of modest means to easily buy shares in almost any publicly traded company. The advent of cheap, passively managed mutual funds and exchange-traded funds has made building a diversified portfolio easier and more affordable than ever."

"Moreover, public capital markets are a good thing. Investors who buy publicly traded stocks or bonds get transparency about their investment with ready liquidity. Meanwhile, private capital investments are often opaque and illiquid. There has been considerable debate about whether private investments generate higher returns. Measuring performance for private equity and private debt is not straightforward. Most industry benchmarks use internal rates of return, which aren't really comparable to traditional performance measures like total return."

"Researchers have examined some of the findings related to this topic. A 2020 paper by Ludovic Phalippou, "An Inconvenient Fact: Private Equity Returns & The Billionaire Factory," argues that net of fees, returns for private equity funds have been in line with those of the public equity markets since 2006. PitchBook, which is part of Morningstar, has also gathered data on public market equivalent returns for private equity. Based on those metrics, private equity funds with 2020-2023 vintage years"

Most investors assume exclusive offerings are better and firms market private equity by invoking exclusivity and 'democratizing' claims. Investing already became more accessible after the SEC removed fixed commissions in 1975, and online brokers plus cheap passive mutual funds and ETFs have lowered barriers to diversified portfolios. Public markets provide transparency and liquidity, whereas private capital tends to be opaque and illiquid. Comparing private and public returns is difficult because industry benchmarks use IRR, which differs from total return. Research including Phalippou (2020) and PitchBook's PMEs indicate private equity net returns have been similar to public markets in recent periods.

Read at Fast Company