Private equity has become an attractive investment choice for those who want to maximize portfolio returns. In contrast to public markets, where companies face intense regulation, private equity offers exposure to a vast reservoir of untapped, high-growth opportunities.
The history of private equity speaks volumes about its value. Research consistently shows that private equity has significantly outperformed public equity over the long term. Comparing returns over year-long intervals, private equity has outperformed public market benchmarks. Private equity has also produced returns similar to emerging market equities and outperformed other legacy asset classes.
Private equity can achieve better results for several reasons. First, it can tap into a large pool of companies outside public markets. Private entities account for approximately 99 percent of the 735,000+ companies in the United States, which means that public market investors cannot access many investment opportunities.
Second, private equity involves active, value-enhancing ownership. Private equity companies enjoy active engagement, from advisory support to reconstruction, unlike public equity investors with minimal control. Most large companies have dedicated value-creation teams tasked with maximizing long-term returns.
Third, private equity better aligns the interests of managers and investors. Whereas public fund managers often receive fees regardless of performance, private equity managers earn management fees and a percentage of profits (typically 20 percent of gains, known as "carry"). This arrangement ties a manager's financial success to investors' outcomes.
Aside from the higher returns, private equity has tremendous diversification value. According to modern portfolio theory, investors should invest in assets with favorable long-term returns and low correlation with current assets. Private equity fits the bill since it is relatively uncorrelated with public markets.
Analysis shows that even in highly integrated markets like the United States, the correlation between private equity buyout funds and public equity has been below 50 percent since 2001. In more fragmented markets such as Europe, the correlation is lower, sometimes even negative. This diversification benefit lowers public market risk as well as cyclical risk.
Private equity firms, particularly value-creation groups, have resisted market downturns. However, McKinsey research found that companies with value-creation teams far outperformed others during and after the 2008 global financial crisis.
Private equity can contribute to higher overall returns while changing risk profiles when included in a diversified investment mix. Although it increases absolute portfolio risk, it often amplifies returns.
Private equity encompasses a range of strategies with distinct features. Buyout investments, the most capital-intensive category, entail controlling stakes in mature companies. Growth equity targets mature companies with high growth, and venture capital targets early-stage companies with rapid growth.
Moreover, private equity involves important considerations. The asset class is highly illiquid, with conventional fund lives of around 10 years and without redemption facilities. Investors must remain prepared for capital calls on multi-year horizons and understand that returns crystallize only on successful exits.
Traditionally, only institutional investors and high-net-worth families with specific requirements had access to private equity. Recent trends have opened access to a broader range of investors through multi-manager methods like co-investments and secondary transactions, which enhance portfolio diversification and capital efficiency. For example, private equity co-investments let investors participate in specific deals alongside general partners, with benefits like lower fees and better transparency. Secondary transactions—purchasing existing fund interests from current investors—offer advantages, including shorter duration, reduced blind pool risk, and faster capital deployment.
