Ben Felix - The Private Equity Pitch

Short Summary

Main recommendation: Be skeptical of the private equity pitch, which is the claim that illiquidity premiums, manager skill, and diversification justify its high fees; Ben Felix argues the data does not support it for most investors unless fees can be negotiated, access to a top venture capital fund is obtained, or both. The main evidence is that private equity returns net of fees have been roughly similar to public equity returns since at least 2006, once measured against risk-appropriate benchmarks.

Key Points

• Private equity performance is hard to evaluate: IRRs are not comparable to time-weighted returns and can be manipulated, so the video relies on multiples of money and the public market equivalent (PME), where a PME of 1.2 means the strategy beat its benchmark by 20 percent cumulative.
• PME results depend heavily on the benchmark; the 2014 paper's sample average PME of 1.2 against the S&P 500 drops to 1.07 against the Russell 2000 Value, and closer to or below one against other small-cap value indexes.
• Venture capital has a skewed distribution: its average PME of 1.2 is driven by outliers, while the median venture fund has a PME of 0.88, and the best funds have limited capacity and exclusive access.
• Ludovic Phalippou's 2020 analysis found private equity funds since 2006 have roughly matched public equity indexes after fees, while 19 new billionaires were minted from the private equity industry between 2005 and 2020.
• Reported private equity returns look diversified only because fair value accounting is not applied to private assets, creating an illusion of diversification; Erik Stafford found that direct investments in private equity funds earn lower mean returns than a replicating strategy of low-priced small-cap public equities plus leverage.

Details Worth Noting

• Concrete instructions: The video gives no step-by-step instructions, but it gives actionable criteria for investors: estimate fees at least six percent unless fees can be negotiated; avoid assuming past good track records predict future buyout fund performance, since buyout funds show no persistence; and only consider private equity if you can negotiate fees, access a top venture capital fund, or both.
• Following the 'Demystifying Illiquid Assets' methodology, the updated Q1 2022 expected real return for current U.S. buyout funds was 5.9 percent net of a five percent estimated fee, compared with about five percent for a global public stock portfolio tilted toward alternative risk premiums; Ben Felix notes he'd use at least a six percent fee estimate, which would bring returns to parity with public equities.
• Vanguard has started making private equity available to some customers, which the video cites as the context for the pitch.
• Private equity funds may selectively time fundraising to coincide with high valuations or inflate asset values when raising new funds, which makes identifying good managers harder.
• The video cites several sources for further reading: Rational Reminder podcast episodes 194 (Bill Janeway), 210 (Ludovic Phalippou), and 216 (Gus Sauter).

Bottom Line

Private equity's advertised advantages largely vanish after fees, leaving most investors with returns similar to public equities at higher cost and risk of poor manager selection.