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Why private equity outperformance will continue – despite the valuation naysayers

There’s nothing mysterious about the performance of private equity, according to Hamilton Lane, and the mundane reasons it does better also means it will keep doing better – even amidst grumbling about valuations.

In its 2024 market overview, Hamilton Lane took aim at the “constant refrain” that private equity outperformance (which has seen, among other metrics, buyout outperform public equities by more than 1000bps in every vintage year) can’t continue.

While critics largely put that outperformance down to valuation gimmicks that effectively put lipstick on a pig, private equity’s outperformance is “closely tied” to better sector selection and a greater ability to create paths for operational growth, the report says – not financial wizardry.

“This is, in the end, the core of the reason private markets outperform… It’s about boring operational performance,” the report states. “The outperformance in 2022, along with the continued performance in 2023, is a simple matter of stronger revenue and EBITDA than public companies.

  • “Throw out any sort of complaints and accusations you like, but there’s no arguing with the data. The answer doesn’t lie in the stars or in the fates, it lies in the numbers on the page.”

    Also contributing to private equity outperformance is the choice of companies, with buyout generally avoiding some areas that are both more represented in public markets and highly volatile, including materials and consumer. Buyout has generally been overweight in sectors that have shown greater growth and resilience during economic cycles, including IT and industrials.

    “More importantly, the size of companies varies drastically, with an average company size of USD$32.5 billion in the S&P 500 versus USD$328 million in the buyout universe. The amount of control you can exert over a smaller company is enormous compared to a larger one.”

    Private equity can also continue to outperform during periods of higher interest rates, the report says, despite a supposed predilection for leverage sensitive to rate increases. While private equity returns were lower during periods of higher rates, the asset class still retained a relative advantage over public markets – which were “negative in all cases”.

    What we see is that investing in a high interest rate environment will likely produce lower returns than investing in a low interest rate environment. High interest rate environments tend to coincide with bull market peaks and are often succeeded by significant recessions, a dynamic that is likely to create lower absolute returns.

    “However… the three year forward returns handily beat the public returns. If private returns are lower, so are public, and you are still easily outperforming your public returns.”

    Staff Writer

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