Are private equity funds still worth it?

Private equity funds have produced an annualised return of around 17% over the past decade, making the asset class one of the best-performing in the world, according to the Cambridge Associates Private Equity Index. However, according to research by the Financial Times blog Alphaville, based on data from Prequin, over the past 13 years private equity funds have called $821bn more from their investors than they have returned. The figures are even worse over the past six years. Private equity funds have taken in a staggering $1.6trn more than they have returned to investors during this period.

Private equity funds drive healthy returns

For readers who don’t know the language of the private equity world, private equity funds will “call” on investors who have signed up to commit capital to a fund when they have found an investment they want to buy. After the fund has bought an investment (there can be tens or hundreds of investments per fund), it will typically hold onto it for three to five years and then try to sell it on, hopefully at a profit. All the money realised from the sale will then be returned to investors, minus any fees. As the Alphaville figures suggest, funds haven’t been selling their investments to repay their investors. They’ve been spending investors’ money but not selling holdings to realise profits. How have these funds produced such lofty returns if they haven’t been selling? Returns are based on net asset values, determined by estimated valuations for portfolio companies. Cold, hard cash does not lie, but estimated company valuations can only be confirmed when the underlying company is sold, which is why investors need to think carefully when buying into any private equity-focused vehicles.