Why Invest in Private Equity? A Comparison of Private Equity and Stock Market Returns

Abstract

Often lauded for offering superior performance, investing in private equity (PE) is costly as investors have to pay fees and committed capital is illiquid for a long-time horizon: Could returns be replicated by levered investments in public markets? This article aims to emulate leveraged buyouts in the public market by purchasing undervalued and poorly performing stocks typical of buyout targets. Similar to LBO transactions, simulated investments are financed partly by debt and realized after five-year holding periods. The authors’ investment strategy yields IRRs of up to 13.2%, less than the average of 14.2% reported in studies that analyze PE performance, but without the long periods of illiquidity that characterize the PE market. Finally, in time periods of economic boom, the authors’ simulated investments outperform those of PE. The authors offer a new investment perspective for investors without the adverse costs of PE.

TOPICS: Private equity, performance measurement, portfolio construction