Oxford academic says industry 'grossly exaggerates' returns

An academic has slammed performance data published by the private equity industry, adding that academic studies consistently show returns are broadly comparable with public equities.

The private equity industry is guilty of exaggerating its performance, according to Ludovic Phalippou, an academic at the University of Oxford’s Saïd Business School. 

He also singled out US university Yale’s endowment funds’ claimed annualised returns of about 30 percent over 40 years from private equity, arguing they were misleading and exaggerated.

Phalippou said: “We often read of the spectacular gains achieved by private equity. But the way the industry reports performance can grossly exaggerate the true numbers. Investors considering this sector should look beyond the headline figures at what lies behind them, and apply better performance measures, so they can make meaningful comparisons with alternatives. An understanding of the pitfalls of current practices is essential.”

I would encourage the private equity industry to re-evaluate how it computes performance

Ludovic Phalippou, Saïd Business School

He believes there is a considerable disconnect between the returns established by academic studies and those set out by the industry itself.

“Industry associations show quite consistently that private equity outperforms public equity by a wide margin, at least in the long run. And the Yale return of 30% is often cited as an example of how much value can be achieved by a portfolio with an aggressive allocation to private equity. Academic studies present a different view, showing that taken all together, private equity funds had returns comparable to those of public equity,” he said.

Phalippou said the disconnect could be attributed to differing methodologies. “We need accurate performance numbers so we can compare returns from different asset classes. This is highly significant as the industry performance reports, or that of Yale, are the only source of performance information for an asset class worth over $1 trillion. I would encourage the private equity industry to re-evaluate how it computes performance.”

UK trade body the British Private Equity and Venture Capital Association chief economist Colin Ellison responded: “It’s always interesting to read one of Ludovic’s pieces, and this one points out some of the potential pitfalls in backward-looking measures of returns. As the paper notes, since-inception returns, which we put most emphasis on, do not suffer to the same degree. His comments on valuations also seem to be a little behind the curve, given our recent paper on this topic.”

The fundamental message is that private equity investing requires skill and expertise. Returns aren’t automatic.

Ross Butler, EVCA

Ross Butler, head of communications at European Private Equity and Venture Capital Association, said: “We agree with the premise that institutional investors should look behind the headline figures. Although the return data out there aren’t nonsense, it’s very easy to point to inconsistencies both up and down. The public markets offer a clearer and more transparent measure of performance and valuation. With private equity, valuation is a much more subjective exercise. Every measure tells a story, be it return multiple or internal rate of return. Even different types of IRR tell different stories.

“The fundamental message is that private equity investing requires skill and expertise. Returns aren’t automatic. It’s a difficult asset class to invest in, but it has an incredible and very successful model. Average returns should not be followed blindly however.”