Private Equity’s Massive Market

By: Gridline Team | Published: 10/11/2023
Est. Reading Time:
2 minutes

Public market investors enjoyed an unprecedented bull run after the great financial crisis. But as interest rates rise and valuations remain stretched, many are finding it difficult to find attractive opportunities in stocks. 

As a Credit Suisse report describes, we are entering a “low return world,” with bond returns under inflation and stock returns expected to deliver significantly lower-than-average returns in the future.

But there is a way to capture far higher returns: private equity. The median PE fund returns a 19.5% net IRR. In contrast, the S&P 500’s projected annualized return over the next decade is just 6%.

Private Equity Captures More of the Economy

Private equity isn’t a smaller slice of the economy—the opposite is true. Buyout firms own more than 10,000 U.S. companies, up from fewer than 2,000 in 2000. That’s more than double the number of domestic US-exchange listed public companies. And the buyout industry has grown to $2.5 trillion in assets under management, more than triple its size in 2010. 

Moreover, private equity firms are increasingly focused on smaller companies—the bulk of their targets. In 2000, 80% of PE-backed companies were valued at between $25 million and $1 billion. That percentage remained consistent even as the industry ballooned—a sign that smaller businesses have been an essential part of the PE landscape for two decades.

The appeal of private equity is clear: it provides access to a large and growing pool of attractive investment opportunities, many of which are unavailable to public market investors. But there are other benefits as well.

Private Equity is More Diversified

One of the key advantages of private equity is that it provides exposure to a far more diversified pool of companies than the stock market. For example, the S&P 500 index is heavily concentrated in just a few sectors, such as technology, finance, and healthcare. In addition, just ten mega-cap companies make up nearly a third of the index.

In contrast, private equity firms own various companies across sectors and sizes. As a result, they are less exposed to the ups and downs of any one industry or company. And because PE firms own so many businesses, they deeply understand different industries and what it takes to succeed in them.

This advantage becomes especially clear during downturns. In both the dot-com crash and the financial crisis, private equity outperformed the stock market, with less steep drawdowns and quicker recoveries. In the decade following the dot-com crash, private markets won again. On average, PE firms generated annualized returns of 7.5%, compared to just 0.08% for the public market index equivalent.

Beyond the liquidity premium, private equity firms are often better able to identify and invest in companies with sound fundamentals that will eventually rebound—something that public markets, which are focused on quarterly results, often miss.

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