Valuations

Eighteen months ago, the most common question we were asked, as private markets were handily outperforming the declining public markets, was how could the valuations in private markets be believed?  

Private Markets: Recent Performance

Let’s start with the elephant in the room: private market performance compared to public markets since the end of 2021. 

Let’s be clear, private equity has lagged behind public markets. By a lot.

the 10 largest stocks in the s&p 500 currently account for over a third of total market cap

market cap of 10 largest s&P 500 firms, % of index total

private & public market cumulative returns

cumulative returns q1 2022 - q3 2024

Infrastructure and real estate have done very well compared to public indices, private credit has been about even, and private equity has badly underperformed. The reaction from general and limited partners is to point out that returns, on an absolute basis for buyout, have been good — with the venture and growth folks telling you that you should only focus on the long-term and ignore that number in red. That’s not the world we live in, is it? Underperformance for this long must be acknowledged. But is this current underperformance the end of private equity’s historical outperformance?

Is there a reason private equity has had such a lag?  One often-discussed factor is the concentration of the public market returns. 

median operational performance

There’s not much doubt that the returns from the public markets are as narrow as they have been in a long time. That narrow set of companies is dominated by large-cap, AI-focused names such as NVDA, GOOG and MSFT. Those are the types of companies that are not represented in private portfolios. When they are outperforming every stock in the world, and represent such a large percentage of public indices, there is no scenario in which you should expect private equity to outperform public markets. But there is an even more fundamental reason why we think public markets have outperformed.

In last year’s market overview, we explained that private markets’ historical outperformance of public markets, particularly on the equity side, was a function of better performance of the companies in private portfolios. Our argument was that valuations on the private side were not artificially inflated but an accurate assessment based on performance. This chart shows that dramatic outperformance in 2023 on the EBITDA and enterprise value side and a little less dramatically for revenue. What about 2024? There is no outperformance. Revenue and EBITDA growth are roughly the same as the public markets’ growth, and there is a small underperformance in the growth of enterprise value. Why, then, the dramatic difference in performance? We’ll argue it’s the inverse of 2023 and tied to the concentration of performance we showed in the earlier slide. The public market performance has been a function of a large multiple expansion in a small group of AI-focused, large-cap companies. These are not companies found in private portfolios. We suspect that, as in prior cycles, the high multiple companies will see some multiple contraction, while the private markets’ continued financial performance will keep multiples there stronger, and this public market outperformance will, as it has over the last 30 years, not continue. But, hey, maybe this time it’s different... 

pooled returns by vintage year

Buyout IRR vs. PME

Longer-Term Performance

Very few of us are investing solely for short-term returns. They matter, but the longer term is why we are in markets, especially the private markets.  What have those returns looked like?   

what the markets have done

growth of $1

Let’s turn to the periodic table of returns, one of our more colorful charts in the overview.

REal Estate IRR vs. PME

private credit irr vs. PME

Infrastructure IRR vs. PME

Let’s start with a vintage year look. A few things jump off this page. First, private credit remains undefeated: 23 straight years of outperforming the public markets. Infrastructure has done so for the last 12 years. It is only private equity buyout and real estate that saw the streak end in the last year. We aren’t betting people, but if we were, we would bet both that the one year is an anomaly as of today and that, in five years, when we look at the vintage returns, the buyout IRR will outperform public returns in every year. Investors assuming that the last year is a window into future performance are ignoring the prior 30 years. Is that the bet you want to make today?

That is the real question posed by this chart: Do you want to believe the consistent outperformance has ended and alter your portfolio accordingly? 

Let’s stay with the longer-term perspective. 

10-year asset class performance

annualized time-weighted return as of 09/30/2024

We are measuring the growth of $1 invested in various markets over the last ten 10 years. Even with the recent underperformance, private equity has given investors much better returns over that period. The chart also shows what a difference the public comparable benchmark you use makes. The S&P 500, one of the world’s best performing indexes, is getting closer to private equity returns, now only about 5% lower. The MSCI is not close and, in fact, has returns that are comparable to what you are getting from private credit and real estate, two strategies with far different risk/return profiles compared to equity. 

Let’s stay with 10-year performance benchmarks. 

Similar to the earlier chart, private infrastructure has outperformed handily. Private equity historically outperforms, but marginally against the heavily U.S.-oriented indices and handily against the global public indices. Your benchmark matters! We throw in hedge funds, as we have every year we have done these overviews, both because we aren’t sure where to list them (some investors categorize them as alternative investments) and because we have told ourselves that there will be an overview where hedge fund returns will outperform something. Somewhere. Somehow. 

Periodic Table of Returns

Pooled IRR by Vintage Year

Periodic Table of Returns

Pooled IRR by Vintage Year

There are several points to consider from this data as you construct your portfolio:

• Venture, which dominated the top of the charts during the teens, has moved to lower performance levels, which is typical of strategies that exhibit far more cyclical returns than some others.

• Look at some of the most consistent strategies over the decades, such as U.S. large/mega or EU buyout: rarely top or bottom performers, but strategies that deliver reliable, strong returns.

• Growth equity has been a real standout for the last 20 years: consistently strong and often close to the best performance in mature vintages.

• Notice how rarely you see negative returns across strategies and vintages.