Private equity investment may not yield higher returns

Investing in private equity funds may not yield as high returns as commonly believed, new research has found.

Many investors believe that higher returns can be achieved by investing in funds which buy firms not listed on stock markets (so-called private equity investment funds) rather than those funds that invest in listed companies.

Private equity funds have become increasingly popular recently with large institution (particularly pension funds and insurance companies), as well as wealthy individuals seeking high returns in an era of low interest rates.

Previous academic studies suggested that investing in private equity funds indeed brings in better results than traditional investment strategies.

"Existing studies are susceptible to selection bias," explained one of the researchers Roman Kraussl of the Luxembourg School of Finance, University of Luxembourg.

"They rely on information reported by the funds' general partners or from large investors, but their experiences are often different from those of the typical private equity investor. We found a way to avoid this selection bias," he said.

The researchers studied the stock market performance of funds that hold portfolios of private equity limited partnerships.

This is a reliable proxy for measuring private equity investment returns because these firms' share prices fluctuate with the performance of their investment portfolios, the study said.

Using this measure suggests that expectations of long-term performance of private equity investments would vary little from the performance of normal stock market indices.

In other words, expected returns are very similar to those of holding listed securities on the major exchanges.

Also, the systematic risk of start-ups (private equity investment) was found to be similar to investing in publicly traded stocks of small and medium-sized companies.

The study will be published in a forthcoming issue of the journal The Review of Financial Studies.