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Private Equity Critics Have It Wrong

By Stephen L. Nesbitt – Chief Executive Officer, Chief Investment Officer of Cliffwater.



A recent Financial Times article1 did a thorough job reprinting a laundry list of past criticisms directed at private equity. This paper responds.

FT: Private equity started because some early nobodies, like KKR, figured out that they could buy a company using a lot of debt and sell it later at a large profit.

Incorrect. Private equity started because many public companies in the 1970s were poorly managed, emphasizing asset growth over shareholder return. A phenomenon called “conglomerate discount” depressed the prices and price-earnings ratios of many companies. Private equity, as an instrument for change of corporate control, became a solution to poor stock returns in that era and ultimately lifted all boats as corporate insiders copied private equity practices for their own survival. And, interestingly, private
equity started when debt wasn’t cheap, but at historically high interest rates. Subsequent strategies like the hostile takeover and shareholder activism owed their start to private equity.

FT: Investor testimonials of strong private equity returns are undermined by (a) questionable use of IRR as the measure of performance, (b) high fees, and (c) misleading public stock benchmarks.

Cliffwater has constructed composite private equity returns achieved by a closed group of large institutional investors. 2 These returns are after-fee and use a time-weighted return methodology, thereby side-stepping concerns expressed in (a) and (b). This research finds an 11.0% composite private equity return across US state pension systems for a 23-year study period.
Addressing issues raised by FT in (c), Cliffwater created a public stock benchmark weighing US and non-US stock returns according to industry information on geographic deployment of private equity assets. This procedure produces a 6.8% return for public stocks, or 4.2% per annum below private equity returns.
Noteworthy is that both US and non-US stock returns equaling 7.13% and 3.92%, respectively,
underperformed private equity returns over this 23-year period.3

FT: Private equity returns can be replicated by combining public stocks with leverage.

Incorrect. Cliffwater’s CEO first raised the possibility of a private equity replication strategy in 1997.4
However, time has shown that the attractive private equity returns can’t be replicated by applying leverage to public stocks. Levering the Russell 2000 index by the difference in its debt-to-total-asset ratio with US buyouts5 would have produced an 8.3% annualized return over the 23-year study cited above. The levered Russell 2000 portfolio underperformed the 11.0% actual private equity return by 2.7% per annum.
Substituting the Russell 3000 index results in a 7.9% return, or 3.1% per annum shortfall to private equity returns.

FT: Future private equity returns will suffer from a “higher for longer” interest rate regime change.

Incorrect. Our research shows that higher interest rates are correlated with lower private equity absolute returns, BUT interest rate levels have no correlation with relative private-to-public equity returns. Instead, what we do find is that private equity tends to outperform public equity in bear markets, perhaps attributable to its “value” investment orientation.

FT: Overweighting stocks of large, liquid alternative investment firms (e.g. Blackstone, KKR, Ares) might be a desirable substitute for illiquid private equity.

Incorrect. First, these large firms are diversified across alternative investments, not just private equity.
Second, their stocks are very volatile with betas sometimes exceeding 2x the market. This volatility may result in their stocks having higher returns, but it is unrelated to why private equity might outperform.
The Case for Private Equity

Stock managers struggle with a market that is largely efficient, which limits their returns to those received by all other investors. For them, this is very frustrating because they create the efficiency that index fund free riders take advantage of. From time-to-time investment luck produces a few billionaires but failure inevitably comes, and often quickly.

Separate from the stock market is the real economy, largely operated by 25 thousand corporate entities generating operating profits which in turn are either distributed to equity investors or held on the corporate balance sheet in the form of cash or other acquired assets. The largest 4 thousand access equity financing through organized public exchanges, whose shareholders have daily liquidity and free access to information but forfeit corporate control. The remaining companies access equity financing through non-public individuals or partnerships. These private equity investors forfeit liquidity but have two important advantages over public shareholders: control and privacy. 

Control allows private equity to directly impact earnings and hence the rate of return. Information privacy protects private equity from competition, thus allowing persistence in return which is not something found in the public markets.

Executing a private equity strategy requires resources from investors, taking the form of higher fees and less liquidity. Cliffwater research shows that private equity investors collectively earn an additional 3 to 5 percent per annum net-of-fee return compared to public stock indices.6 That research also shows that top-quartile allocators to private equity can another 2 to 3 percent per annum from selection.7 With a combined 5 to 8 percent return opportunity over public stocks, it is no wonder that the private equity market is growing at twice the rate of the public stock market.


1 “Is Private Equity Really Worth It”, Financial Times, March 5, 2024.
2 See Cliffwater Research, “Long-Term Private Equity Performance, 2000 to 2023”, January 26, 2024.
3 Cliffwater proprietary research.
4 “Benchmarks for Private Equity Investments”, S. Nesbitt and H. Reynolds, Journal of Portfolio Management,
Summer 1997.
5 Source: Pitchbook, Bloomberg.

About the Author:

Steve Nesbitt is the Chief Executive Officer and Chief Investment Officer of Cliffwater, and is primarily responsible for the day-to-day management of Cliffwater Corporate Lending Fund (CCLFX) and the Cliffwater Enhanced Lending Fund (CELFX), an SEC registered credit interval fund focused on the US corporate middle market.


Steve is recognized for a broad range of investment research. His papers have appeared in the Financial Analysts Journal, The Journal of Portfolio Management, The Journal of Applied Corporate Finance, and The Journal of Alternative Investments. His private debt research led to the creation of the Cliffwater BDC Index, measuring historical BDC performance, and the Cliffwater Direct Lending Index, measuring historical performance for direct middle market loans. Steve authored the book, Private Debt: Opportunities in Corporate Direct Lending, Wiley Finance (2019) which provides the analytical and empirical underpinnings of the private debt market.

Stephen L. Nesbitt

The views expressed herein are the views of Cliffwater LLC (“Cliffwater”) only through the date of this report and are subject to change based on market or other conditions. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. Cliffwater has not conducted an independent verification of the information. The information herein may include inaccuracies or typographical errors. Due to various factors, including the inherent possibility of human or mechanical error, the accuracy, completeness, timeliness and correct sequencing of such information and the results obtained from its use are not guaranteed by Cliffwater. No representation, warranty, or undertaking, express or implied, is given as to the accuracy or completeness of the information or opinions contained in this report. This report is not an advertisement, is being distributed for informational purposes only and should not be considered investment advice, nor shall it be construed as an offer or solicitation of an offer for the purchase or sale of any security. The information we provide does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. Cliffwater shall not be responsible for investment decisions, damages, or other losses resulting from the use of the information. Past performance does not guarantee future performance. Future returns are not guaranteed, and a loss of principal may occur. Statements that are nonfactual in nature, including opinions, projections, and estimates, assume certain economic conditions and industry developments and constitute only current opinions that are subject to change without notice. Cliffwater is a service mark of Cliffwater LLC.