Private Equity Returns
Private equity returns run in cycles and are strongly influenced by such factors as market conditions, credit markets, company valuations, liquidity for exits, merger and acquisition activity, and other factors, including the amount of money looking for exposure to the asset class.
Looking merely at the 12-year period ending in 2010 enables us to observe the turmoil that can afflict the world of PE. In the late 1990s, investor enthusiasm for investing in emerging technologies led to the now famous Tech Bubble, which burst dramatically in 2000. Returns stagnated for years as the industry retrenched. The bear market for public equities that stretched through 2000 and 2001 further depressed the PE markets, placing pressures on exits and therefore on returns.
Still, as the markets languished and as investors fled PE, PE firms investing in smaller buyouts continued to operate below the radar, ultimately producing handsome returns later in the decade.
As liquidity built during the strong public equity markets of 2005–2007, the market for large buyouts became extremely active and for a short period returns were spectacular. But when the credit markets collapsed in 2007, this party came to a quick end, shocking many overextended PE investors (especially endowed institutions6). At the same time, the secondary and distressed PE sectors took off.
My point here is that no one could have foreseen this turmoil or timed their PE investments to take advantage of the ups and downs of the various sectors. Instead, PE investing requires great discipline and steady commitment. Investors who fail to build strong vintage year diversification into their portfolios can get badly burned.