[cmdkeen]

It's more complicated than that - as the article says PE can be used to diversify an investments. If you have a few extra billion you might not want to tie it all to the performance of the US equity market. So PE doesn't have to beat the S&P to be attractive if the ups and downs happen at different times to the S&P.

Then there is also the question of fees, if the fund is beating the S&P by 1-2% after fees, and their fees are 2 and 20 then the strategy is significantly beating the market. The problem is that there is so much money chasing PE, and that leverage means they don't need that much in client funds, that there isn't a push to lower fees that you see in the equity market.

[StevePerkins]

> "If you have a few extra billion you might not want to tie it all to the performance of the US equity market."

Yes, but... Vanguard's S&P 500 fund isn't the only index fund on the planet, either. You can include a broad international fund, a region or country-specific fund, or any other number of factors. Diversification and passivity are orthogonal.

> "if the fund is beating the S&P by 1-2% after fees"

Yes, but:

1. You're taking on a higher degree of risk, because the information available to you is much more opaque and unregulated (e.g. EBITA as a valuation metric, when it's so easy manipulated). Bubbles are hard to time, even when you do have decent data available. But investors in that world are just completely flying blind. And historically received only a small net premium for that additional risk.

2. Even that historical premium seems to be gone now. As I pointed out from the article, that "1-2%" is looking back over a quarter-century timeframe. Over the past 10 years, half of PE has UNDERPERFORMED the market. The direction of the trend does not look favorable.

[clomond]

Hey Steve, while you are correct I think the confusion is related to what cmdkeen (and the article authors) mean by diversification.

Whilst your comments are valid for public equity - this is simply one of several types of "asset classes" someone with billions of dollars has access too. Different, non-public asset classes can have properties distinct from bubble risks or liquidity.

One of the key benefits of holding a variety of asset classes, particularly the more exotic ones - is that their performance can be uncorrelated with the performance of the stock and debt markets.

Some examples of PE asset classes:

- Venture Capital (very high risk, but over a long period of time is supposed to generate 20-30% rates of return)

- Angel Investing (higher risk still, and you need many companies but also generating 20-30% returns with a big enough portfolio)

- Commercial real estate (uncorrelated to global equity market performance - rather its connected to local market performance, pretty sure around 10% can be typical for offices)

- Infrastructure projects (uncorrelated again, lower rates of return but you are locking in those returns for decades)

There are tonnes of course, but when you start talking about personally investing such large sums of money - diversification means a lot more than just buying investments in the public markets (either bonds or stocks).

[batmenace]

Regarding 1. the risk can also be substantially lower for PE firms, because A. Extensive FVDD (Financial Vendor Due Diligence) and other types of risk assessment are carried out over the negotiation phase, and you are far less susceptible to stock market movements. Also, unlike investing in public companies, the PE fund is almost always the sole investor in the business alongside a small management tie-up, meaning you actually have full control over the business financially and strategically

[bryanlarsen]

You can increase your returns by diversifying into uncorrelated assets even if that other asset has returns that underperform the market.

That's why you see the 80/20 stock/bond split recommended so often. Even though bonds underperform stocks, the 80/20 split regularly rebalanced outperforms 100% stocks. Rebalancing is an automatic "buy low / sell high" strategy. After a stock market crash your 80/20 split might be 50/50 so you take that 30% and buy cheap stocks...

[avn2109]

No matter how much you diversify your long-only strategies, you will still not even be close to market neutral, which is probably what you really want at that scale.

[pmart123]

With LBOs, much of the outperformance is due to leverage. If you could lever up the s&p 500, say 25%, you’d likely get much better returns. Because PE firms don’t aggressively revalue assets, they don’t have to face margin calls the same why someone would with an asset that is priced daily.

[bradleyjg]

Should we really expect PE results to be un or weakly correlated with publicly traded companies?