In a November 2024 article, Cliffwater showed the EBITDA multiples for private and public equity for the 27-year period from 1997 through the third quarter of 2024. Multiples were measured by the ratio of total economic value, which includes both equity and debt, to earnings as measured by EBITDA. Pitchbook and S&P Dow Jones Indexes are the data sources for US buyouts and the S&P 500, respectively—the proxies for private and public equity. As the chart below demonstrates, valuation multiples are much higher for stocks when compared with US buyouts over the entire period.
Cliffwater found that EBITDA multiples averaged 29% less for US buyouts compared with the S&P 500 Index over the nearly 27-year period. The private equity valuation discount, shown by the dotted line, varied over time. However, it was consistently positive, and it is at about its long-term average. The private equity valuation discount provides important insights into the historical performance of private equity.
Historical Performance of Private Equity
In an April 2024 article for CAIA, Stephen Nesbitt, chief investment officer and CEO of Cliffwater, found that private equity allocations by state pensions produced an 11% net-of-fee annualized return over the 23-year period ending June 30, 2023. Over the same period, the CRSP 1-10 Index (US total market) returned 7.2%, and the MSCI All Country World ex USA Index returned 4.4%. The 29% discount produced a 3% higher earnings yield on private equity when compared with public stocks, explaining about one half of private equity’s outperformance versus public US stocks.
The historical 3% contribution to private equity returns from a higher earnings yield, plus an assumed 3% contribution (an average of a 0% elimination of the discount and a maximum of 6%) from multiple convergence, produces a 6% excess return for private equity, gross of fees, and expenses.
Based on its experience as an advisor to pension plans investing in private equity, Cliffwater assumed expenses of a 1.0% management fee, 20.0% carried interest, and 0.2% in administrative fees. Assuming a 7.0% return on public equity and a 13% gross private equity return (7.0% plus 6.0% premium), private equity investors would earn a net return of 9.2% (2.2% excess return) in return for accepting the illiquidity risk of private equity.
A Confluence of Factors Supports Private Equity
A confluence of factors has created an environment in which it seems particularly attractive to invest in private equity. Let’s examine these factors.
Diversification
At the end of the 1990s, there were more than 8,000 companies on US public stock exchanges. The passage of Sarbanes-Oxley led to a dramatic increase in the cost of being a public company. The result is that the number of stocks public has shrunk by more than half. Small to mid-size companies are waiting much longer to go public. Thus, investors have much less opportunity to invest in smaller companies, companies with higher growth potential. Private equity provides that access.
Narrow Credit Spreads
The spread between Baa corporate bonds and US Treasuries over the past 50 years is almost at a 50-year low, despite widening in recent weeks as a result of the uncertainty over tariff policy.
The low credit spread not only enables private equity firms to borrow at rates that make investment in private companies more attractive but also makes it more attractive for public companies to acquire private companies.
Valuations of Large and Growth Companies Versus Value and Small Companies
Over the period 2016-24, Vanguard Russell 1000 Growth ETF VONG outperformed Vanguard Russell 2000 Value ETF VTWV by 9.2 percentage points per year (18.0% versus 8.8%). That outperformance has resulted in the relative valuations of large-growth companies becoming dramatically higher. As of March 31, 2025, the forward P/E of Vanguard Russell 1000 Growth ETF was 28.9 versus just 11.7 for Vanguard Russell 2000 Value ETF—a ratio of 2.47. At the end of 1999 (just before the dot-com bubble bursting), the P/E ratio for US large-growth stocks was 30.3; for US small-value stocks, it was 12.3, producing a ratio of 2.46, virtually the same spread as now exists. By comparison, at the end of 1994, the P/E ratios were 15.8 for large-growth stocks and 11.7 for small-value stocks—a ratio of 1.35.
Their much higher valuations provide large-growth stocks with cheap capital they can use to buy smaller-value stocks, giving them the incentive to engage in acquisitions (which have historically narrowed the gap in valuations between public and private companies).
Note that the same relative valuation spread applies to small stocks in general. Vanguard Russell 2000 ETF VTWO underperformed Vanguard Russell 1000 Growth ETF by almost 9 percentage points per year over the period 2016-24, resulting in a widening of the valuation spread. As of March 31, 2025, the forward P/E was 14.1, producing a ratio relative to Vanguard Russell 1000 Growth ETF of 2.0. The wide spread provides the opportunity for large companies to use their less expensive capital to acquire smaller, cheaper companies (many more of which are now private, not public).
Valuations of US Versus International Companies
The dramatic outperformance of US stocks over the period 2008-24 was mostly the result of their relative increase in valuations—which we can see in current valuations. The forward P/E of Vanguard 500 ETF VOO as of March 31, 2025, was 20.9 versus just 14.2 for the iShares Core MSCI EAFE ETF EFA, a spread of 6.7. That is 63% wider than the average spread of just 4.1 over the period 2000-23.
We find a similar situation when looking at emerging markets. The forward P/E of Vanguard FTSE Emerging Markets ETF VWO was 13.0, resulting in a spread of 7.5. That is 56% wider than the average spread of 5.9 over the period 2000-23. The wide spread creates the opportunity for US companies to use their much cheaper capital to acquire foreign companies.
Strength of the Dollar
While the “tariff war” has led to the US dollar losing about 10% of its value since the end of 2024, the value of the US dollar index is still about 24% higher than it was in 2010 (about 80 versus about 99 on April 22). Both private and public companies can take advantage of the differences in valuations discussed above, as well as the strength of the dollar, to acquire foreign companies.
Sluggish IPO Market and M&A
There is one other issue we need to discuss. The sluggish IPO market and cautious merger-and-acquisition activity in 2025 have created a chain reaction in private equity markets, prompting institutional investors to offload positions, opening opportunities for discounted secondary purchases. Here’s how these dynamics interconnect:
Reduced Exit Opportunities Drive Portfolio Rebalancing
The IPO market, while recovering from 2022-23 lows, remains subdued compared with pre-2022 levels, with only 59 US IPOs in the first quarter of 2025 amid trade tensions and volatility. Similarly, M&A activity has slowed sharply in early 2025. For institutional investors like pension funds and endowments, these conditions limit traditional exit routes (IPOs, trade sales), causing private equity allocations to exceed target thresholds. To rebalance, institutions are increasingly turning to secondary markets to sell PE holdings at discounts.
Secondary Market Opportunities Emerge
The surge in supply of private equity assets in secondary markets—driven by rebalancing needs—has depressed prices, with average limited-partnership-led secondary transactions priced at 89% of net asset value in 2024. This discount reflects both liquidity demand and uncertainty around exit timelines. The large discount creates an opportunity for buyers.
Summary of Opportunities
Despite recent events, including a widening of credit spreads, the fall of the dollar, and weaker equity markets, US large companies still have a unique opportunity to use their higher valuations—with assistance from still relatively low credit spreads—to buy small to mid-size US companies (often private companies) with their much lower valuations, as well as international stocks (aided by the still relatively high valuation of the US dollar).
Private equity firms can also benefit from the still relatively low credit spreads and low valuations to buy companies and eventually either take them public or sell to a strategic buyer.
In addition, private equity has the opportunity to take advantage of secondaries sales by institutional investors who need to rebalance portfolios.
Larry Swedroe is the author or co-author of 18 books on investing, including his latest, Enrich Your Future: The Keys to Successful Investing.
Correction: A reference to CAIA was corrected to the proper letters.
Larry Swedroe is a freelance writer. The opinions expressed here are the author’s. Morningstar values diversity of thought and publishes a broad range of viewpoints.
