E196: Professor Steve Kaplan: Do Privates Really Outperform the S&P 500?

Why do Harvard and Yale seem to be exiting private equity? What does the most rigorous data actually say about buyout and venture performance? And how should serious LPs think about real estate, hedge funds, and co-investments? In this episode, I’m joined with Steven Neil Kaplan—Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business, co-creator of the Kaplan-Schoar PME metric, and one of the most widely cited academics in private equity and venture capital. Steve breaks down decades of private market performance data, busts myths around IRRs and overmarking, and gives a rare, honest evaluation of asset class performance through multiple cycles. This conversation is a masterclass in understanding what the real numbers say—direct from the person who helped shape how performance is measured.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00David Weisburd?

  Why is Yale and Harvard getting out of private equity?

• 0:04Speaker 01

  That's a good question. I am not entirely sure, but I think it's a combination of things. I think, first of all, Harvard and Yale both have some liquidity issues. They probably felt they were a little too illiquid. And so by selling some of their private equity portfolio, they get more liquidity. I would guess, too, they looked at their portfolio and they saw some funds that they were either not too happy with or were happy to get out of.

• 0:43Speaker 01

  And third, I think the bid-ask spreads, I imagine, in the secondary market were tight enough that selling, they were able to sell it at what they thought were reasonable values. So I'd say those are probably the three things that have led to the sales.

• 1:01David Weisburd?

  If Yale gave you a call, let's say Matt Mendelson, the CIO, gave you a call and said, "How should I get liquidity in my portfolio?" What would you advise them?

• 1:08Speaker 01

  Yale, I think, allocates too much to hedge funds. Hedge fund performance has not been great over time relative to other things. So first of all, I could reduce my hedge fund exposure. I also would say the same thing about infrastructure and real estate. So I would take my allocations a little different from Yale in order to get some liquidity. And then I'd be... Go ahead.

• 1:42David Weisburd?

  One of your research papers took a look at buyout, private equity returns between 2000 and 2017, and it found that, on average, buyout outperformed by 4% versus S&P 500. Tell me about that research and how did you go about ascertaining that performance?

• 1:58Speaker 01

  This is all ongoing, and I'm going to give you the most up-to-date numbers in a second. But the the research started many, many years ago. No one really knew anything about private equity performance. And Antoinette and Shaw, who's at MIT, and I wrote one of the first papers looking at private equity performance. It was 2005. And we use data from venture economics. And we came up with a measure that is called the Kaplan-Shaw Public Market Equivalent that allows you to compare apples to apples, private equity, whether it's buyout and venture, with whatever index you choose.

• 2:43Speaker 01

  We chose the S and P 500. It turned out the venture economics data were bad. And I'm going to come back to that later when we talk about Ludo. Since then, I've been using the the Burgess, now MSCI data, which are the the absolute best data on private equity performance. They're much better now. Burgess gets their data from limited partners, usually institutional, so it's pension funds, sovereign wealth funds, endowments. And because those data sources are LPs, there's not a selection bias. They're getting the data from the buyout funds, the venture funds, whatever it is.

• 3:28Speaker 01

  And Burgess takes the data and then we have access to it. So this is is now very, you know, it's data that is as clean as you can get. They're still, you know, not perfect because you don't know everything that's out there. But this is the best data there is. And so the most recent data, if you look at buyout funds in North America from 2000 to 2019 vintages. And those are good vintages because, you know, it's the data are through the Q1 of 2025. So the 2019 funds are at least five years old. And if you look at how those funds have done.

• 4:11Speaker 01

  As of today, and the more recent funds, there's still some, you know, they're not fully realized. It could move a little bit because of, you know, net asset values, but they are currently running at 360 basis points above the S and P 500 over that period. And or everything raised 2000 to 2019 as a 125 is 360 basis points over the S and P 500, which is, is, you know, spectacular. And it's why so much money went into private equity. If you then, you know, compare it to the Russell 2000, which is maybe a better

• 4:53Speaker 01

  benchmark for private for buyout funds because they're not, you know, they're not buying big companies. They're buying mid cap to 460 basis points. So the performance has been very good.

• 5:07David Weisburd?

  Private markets, because there's lack of standardization and there's all sorts of biases. You mentioned one of these biases, LP drive data from GP derived data. There's also all sorts of marketing biases, standardization biases. It's actually incredibly valuable to have standardized data. So you created this Kaplan Shore Index. Tell me about what that index is and how did you normalize data from private equity to the S and P?

• 5:34Speaker 01

  There are two ways to look at it. One is sort cumulatively, which would be sort of like a market adjusted multiple of the fund. So what it basically does is says, okay, if the private equity fund calls capital, let's say it calls a calls $100 million, we put $100 million into the S and P 500 that day. And then, over the life of the fund, when the fund, when that money comes back, let's say we got a $300 million realization five years later, we compare that 300 million to what you would have returned.

• 6:22Speaker 01

  If you put the 100 million in the S and P 500. So if the S and P 500 went from 100 to 200 over that period and you got 300, that's a PME of 1.5. You have beaten the S and P 500 by 50%. The S and P 500 went to 400. Well, now it's 300 divided by 400. Your PME is 0.75. You have underperformed the S and P 500 by 25%. So the public market equivalent is basically saying apples to apples. You put your money in the S and P 500, you put it into the private equity. If it's greater than one, you've done better than the S and P 500.

• 7:07Speaker 01

  And that number for private equity for those vintages I mentioned is 1.13. So it's 13% cumulatively better than the S and P 500. And the S and P 500 went up quite a bit over this period. You can then annualize it to something called a direct alpha, where you're basically taking that 13% over the life of the fund and doing an IRR on the excess. And that's the 360 basis points that I mentioned earlier. Something like 15% versus 11% would be a back of the envelope guess on that.

• 7:47David Weisburd?

  When you look at this data, when you look at the data 2000 to 2019, how much roughly is the S and P growing on a yearly basis versus buyout over 19 years?

• 7:56Speaker 01

  So I would say it's sort of 15 versus 11. So you would have done, and that's about the 400 basis points that I mentioned.

• 8:04David Weisburd?

  So using the rule of 72, it's roughly doubling every five years versus doubling every...

• 8:13David Weisburd?

  Six and a half years, which doesn't sound like a big difference, but it certainly compounds dramatically.

• 8:18Speaker 01

  It certainly compounds. 360 basis points a year is a big difference.

• 8:23David Weisburd?

  Out of curiosity, do you also add dividends into the S and P 500 as well?

• 8:27Speaker 01

  Yeah, so the S and P 500, you absolutely have to do that. So the S and P 500, it includes dividends, which are roughly 2% a year. And the buyout fund performance would include all distributions. So it's really, it's an apples to apples comparison, which is why it's, and it's very simple to calculate, actually, which is why it's such a nice, we thought it was a nice metric to use.

• 8:56David Weisburd?

  One of your colleagues at Oxford, Ludo Filippo, is this private equity critic, just stating his bias, and he believes that a lot of these metrics are gamed, IRRs can't be eaten, and there's a lot of gamification from the private equity industry. Why is he wrong?

• 9:13Speaker 01

  He's wrong in that he's actually misleading on a number of things, and he's wrong on a number of things. And he's actually been wrong for quite some time. I'll say something nice about him later, that there's some things that he's right about. So these numbers that I gave you are based on cash flows. So these are not IRRs, these are not things you can't eat. These are based on cash flows, with the exception of the unrealized investments that are still in the funds. 2017, 2018, 2019 vintages, those aren't fully realized.

• 9:58Speaker 01

  So the numbers I gave you could move a little bit because we're basing what's left in the portfolio on the marks. But everything else is realized. I mean, this is 2000 to 2015. These things are very realized, and those are the numbers. And those have been the numbers. So to say, some people say there's volatility, people playing games with volatility, playing games with IRR, those numbers I gave you, those are quite real. So that's number one. To say they're not real is wrong. And Ludo doesn't say that. The second thing that he's done on a number of occasions is not done in apples to oranges

• 10:43Speaker 01

  calculations. So what he'll do in a lot of these things is he'll put private credit, he'll put real assets in with the buyout and the venture, and then he'll compare them to the S and P 500. Well, buyout and venture absolutely compared to the S and P 500. Private credit? Are you kidding? That shouldn't have an S and P 500 type return. And then real assets and real estate and infrastructure, I think you can debate. But if you take out the private credit, the real assets, the infrastructure, these results are are super

• 11:28Speaker 01

  strong through the 2019 vintages. So he sometimes mixes apples to oranges. And in several of his things, he used the least favorable time periods to private equity. But if you use this long period, 2000 to 2019, what I just told you is what you get. So there's there's just no way to say buyout performance hasn't been very good through those vintages. Now, where where he may turn out to be right, which is, you know, we'll see, are the more recent vintages. So 2020 to 2022 vintages, which invested a lot of

• 12:08Speaker 01

  money in the craziness and around the pandemic, where prices got very high. Those vintages right now have PMEs of about 0.98 and the direct alpha of minus 1% versus the S and P. So they're they're coming in S and P like at the moment, and they could end up lower. What's interesting is they're still beating the Russell. So the Russell, they're beating the Russell by like the PME is 1.22. That means cumulatively 22% better and an 8% annualized outperformance.

• 12:49Speaker 01

  So if you think the Russell is the right benchmark, you know, those vintages are going to be okay. If you think it's the S and P 500, maybe, maybe not. So maybe Ludo will be right. But what I'm doing and have done consistently is apples to apples. Look at, you know, the time periods, be very clear about what you're looking at. And, um, you know, that's, that's what I've done. The other place where I think he's, again, I, I, I think I agree is real estate and real assets have not performed so well and on an absolute basis and relative to the S and P. And, and infrastructure probably not as well.

• 13:33Speaker 01

  So if I were, were advising an endowment, I would steer clear or not do very much of infrastructure or real estate. And I would, uh, you know, stick to, you know, what I think is, is real private equity.

• 13:52David Weisburd?

  And you advise that because real estate has worse performing returns. So even if it adds some more diversification, real estate and infrastructure on a expected value, you're actually lowering your returns. What about diversification?

• 14:07Speaker 01

  The diversification is, is the, the infrastructure, infrastructure, I think is, is the jury is out. The, the returns have been low. If you, you look at it relative to the S and P, the returns have been low. If you look at it relative to, you know, some infrastructure index and public companies, it looks better. And so you kind of have to decide what you're doing with infrastructure. Are you looking for a return or are you looking for diversification? The real estate even sort of underperforms the, you know, the real public real estate indexes. So the, the real estate has really not been a great place in private equity. I also, the, the other thing I think about is.

• 14:52Speaker 01

  You're paying these fees, which are not trivial, whether it's two and 20 or one in 10, depending on the asset class. And you're paying those fees because the PE firms are adding value. And so where are they going to add value? On the buyout side, they're doing it right. And a lot of these companies, the private equity funds, try to do it right. They're adding real operational value to these companies. Infrastructure, I think it's a little harder, but you might be able to. Real estate, what are you doing? You're buying low, selling high.

• 15:36Speaker 01

  I'm not sure how you add value to a building over somebody else. So I think the value added is potentially much higher on the buyout and venture capital side. So there's some hope or expectation that they'll earn their fees. I think it's harder in some of the other asset classes.

• 16:00David Weisburd?

  When the Capital Insurance Index is comparing buyout to S and P 500, you're doing on a net basis. So what the LP would get, not what the private equity.

• 16:10Speaker 01

  Absolutely. And that's very important. It's net of fees on the private equity side. And on the S and P side, actually, we use the S and P. So if you think there's a little bit of fee or a little bit of friction, we're kind of biased against the private equity by just using the S and P 500. Although you can, you buy an ETF, the fees are very low.

• 16:35David Weisburd?

  I'm not some kind of private equity or venture apologist. I try to look at the market, although I have a bias. I do think it performs better. It's good to see that the data shows that. But it seems to be the wrong way just because S and P has had a five-year run. If you really double click on that, that's the magnificent seven, the Tesla, Microsoft, Apple, Meta. And maybe now they're slightly overperforming by 2%. Doesn't mean that it was a better decision at the time of investment. How far back does this data go? And how conclusive is it over a multi-decade timeline?

• 17:09Speaker 01

  You're absolutely right, and that's why the Russell is interesting, right? Because the S and P has crushed the Russell. And going back to Falapu and what also some other people say about private equity, they used to say in 2005, 2010, oh, buyout investing, that's small cap value. If I just leveraged small cap value in the public markets, I'd outperform. Well, small cap value has been terrible the last 15 years, and it's been crushed by the Russell. Russell value has been worse than Russell, which has been worse than S and P 500.

• 17:54Speaker 01

  So you kind of have to think about what the right comparison is. And then I think you are getting diversification, which I think is your point, that when you invest over the long haul, there are going to be some periods where one asset class outperforms the other. And as long as they don't move exactly together, you should get, let's say they have the same return, not a better return, but they're moving differently. By investing in more than one asset class, you're getting the same return with less risk. And so that's where certainly if you put a lot of money into buyout funds 2000 to 2019, you way outperformed, even though over the entire period,

• 18:39Speaker 01

  even though you didn't outperform over every individual period, which goes to your next question, going forward, what makes sense? That's where it's really, it's super hard because it's a lot easier to look backward than it is to predict the future. You have to come to some...

• 19:03Speaker 01

  I guess expectation, what is this asset class going to do in terms of return relative to, say, the S and P 500? Is it uncorrelated or not perfectly correlated? And then the right answer is, if you think these asset classes have similar returns or private equity might be slightly higher, then you allocate to each of the asset classes, which is diversification.

• 19:33David Weisburd?

  How much is S and P correlated with buyout?

• 19:37Speaker 01

  This is sort of the shocker, or it's surprising, is they're not perfectly correlated. So you definitely get diversification benefit from holding buyout and the S and P 500. And you can see that from what I just showed you. Buyout outperformed those vanages through 2019, and buyout has underperformed probably 2020 to 2021. So they're not moving in lockstep. And the returns have been higher on the buyout. So you get some higher returns and you get diversification benefit.

• 20:22Speaker 01

  The other question people ask, which is, is buyout just a leveraged investment in the S and P 500? And if it were a leveraged investment in the S and P 500, you would see two things. Number one, you would see them move in lockstep, which you haven't seen them do. I just told you they didn't move in lockstep. You would also see a beta.

• 20:55Speaker 01

  Well above one and what a beta is, is how the returns on a private equity fund move with the returns on the S and P 500. So if they were, you were just, the buyout fund was just like the S and P 500, the beta would be one. If it were a leveraged investment in the S and P 500, and we think buyout firms probably have 50, 60% leverage, public companies, 10, 20%, that'd be like a 40% difference, you'd see a beta of 1.4 or 1.5.

• 21:35Speaker 01

  And you actually see betas of one when you estimate based on, and this is based on cash flows, not, not marks. So they have kind of the same risk as the S and P 500. They don't move like the S and P 500 and that gives you diversification benefit.

• 21:59David Weisburd?

  Double click for, for the audience, one of the most important things about Burgess and LP-driven data, one is it's driven by LP, so there's no survivorship bias and there's no GPs only sending data in when it's positive. The second one is this aspect of DPI. DPI is ground truth. You could hem and haw for 20 years, say, I'm good, I'm bad. You could under, understate, overstate. The proof, proof is in the pudding. What dollars do you return back? That is an objective measure. One thing that I've learned from talking to hundreds of investors, founders and business leaders is that planning for the future isn't just about growing assets, it's also about protecting the people who matter most. Life comes with a lot of important milestones. Maybe you're buying a home, starting a family, planning for college, or simply thinking

• 22:43David Weisburd?

  more intentionally about your financial future. As those responsibilities grow, it's worth making sure you protect those you love. Not sure what kind of life insurance you may need? Concerned about how much it may cost? Think life insurance is too complicated? Your local State Farm agent can help answer those questions. They can help you explore your options for life insurance and choose coverage that you can adjust as your family's needs change over time. Financial protection for your loved ones when it matters most. Learn more about life insurance at statefarm.com. Like a good neighbor, State Farm is there. So that's where you're focused on, which I think is, is great. The, the marks themselves are very interesting. There seems to be a bias depending on vintage and manager, whether somebody would. Overmark or undermark their TVPI.

• 23:25David Weisburd?

  On the overmarking, they're going into fundraising cycle. They want to raise capital. On the undermarking, it's just the rule of conservatism. You don't want a Yale endowment that gets a 1.75X mark and the next quarter is 1.7X. It just doesn't make you look good. So a lot of established managers don't like that. But I want to go into the data, not in terms of narratives or your personal views. What does the data say when it comes to whether private equity buyout and/or venture managers undermark or overmark as a general rule? And also, in which cases does the data show that one or the other happens?

• 24:04Speaker 01

  I've written two papers on this, at least. So number one, historically, and this is before the 2021 period where they went into deals at high valuations. Historically, on average, they undermarked a little bit. So this is your point, that they want to be a little conservative, right? And then the times when you do see them being a little more aggressive is when, as you said, when people are fundraising. And there are two things that go on when people fundraise.

• 24:47Speaker 01

  People tend to fundraise when they're top quartile. So when do you fundraise? You have a great realization, something good happens, that's when you go. And if your fund is not doing well, you don't fundraise. You wait until it is doing well. So it's pretty amazing when you look at who raises funds. There are like very few bottom quartile or even third quartile funds. It's mainly top quartile and second quartile. And what that means is when you fundraise and you compare yourself to other funds that were raised at the same time as your previous fund, you're ranked in quartiles

• 25:32Speaker 01

  by the Burgess's, the Pitchbooks, the Cambridges. And people go when they look good relative to their comparison set. So. People tend to go when they've had good performance and then the poorer performers tend to write their assets up a little bit around fundraising. So, and people are aware of this. I mean, you, you, you know, if you're an LP, you understand and you should be looking at the unrealized investments in the previous fund to see the extent to which they're doing that. And I think LPs understand that.

• 26:16Speaker 01

  So, the first two questions, you said, what is the, you know, what do people do? They, they basically, as you said, the marks historically are a little conservative. They get less conservative when people are fundraising. And that's the, you know, what you see at the, the fund level. The, the people now saying that the, the marks, everything's overmarked is probably, comes from, you know, that 2021 period where they made a lot of investments at high valuations and they haven't fully written them down. So, we'll see what happens going forward, how much of that turns out to be overmarked.

• 27:01Speaker 01

  And I think it's, it's too early to tell, obviously, on the, the research because you've got to see how those, what valuations those investments get sold at.

• 27:13David Weisburd?

  A very famous manager, I no longer repeat his name because it's not the best quote attributed to him, but says that asset management is about having average return and great customer service. Now, clearly, it seems like it's, people don't fundraise when they're in third and fourth quartile, but to what extent is that true? That if you have median returns and just great customer service and great LP management and maybe great transparency, whatever else you would group in that bucket, to what, to what extent do you see funds that are able to do that continue to survive and thrive?

• 27:48Speaker 01

  So I won't name names because I, well, I could, but I won't, at least initially. Is if you look at the performance of the mega funds that were raised post-Great Financial Crisis, vintages 2009 to 2019, and look at mega funds, which were more than $10 billion. Those funds, actually, their PMEs are lower than the average buyout PME. And I think, you know, some of them have performed S and P like.

• 28:30Speaker 01

  And, you know, as a rose, they're a little overall, they're a little bit over the S and P. Some of them are S and P like, and they still raise a lot of money. So the, the mega funds, I think, are, are as a class in that bucket where their, their performance post-GFC has not been as good as the middle market folks. But they've continued to raise a lot of money and they've delivered, you know, okay, overall, somewhat better performance than the S and P 500, but not as good as some of the others, but they give, probably give good customer service.

• 29:14Speaker 01

  They also allow you to write big checks, so there's, there's an economy of scale. And again, we'll see whether, whether that continues over time as people say, gee, the returns here are less than the returns at some of my alternatives.

• 29:32David Weisburd?

  You're a great researcher and you don't like to speak off the cuff, but if I forced you to guess why LPs continue to invest into these funds, what would be the one or two factors that you think is driving LPs to invest in these mega funds that are underperforming that 7500?

• 29:49Speaker 01

  There's, I'm gonna give a positive caveat to that. Even though the fund, let's say the fund is S and P 500. They also get co-invest rights in a number of these funds, the larger investors. So, and on the co-invest, they're not paying fees. So the blended, you know, S and P 500 on the fund and better than S and P 500 on the co-invest, they're beating the S and P 500. So I think I'll pull that back a little bit, that the larger investors will beat the S and P 500 less than they would have on sort of the smaller mid-market buyout funds.

• 30:32Speaker 01

  And I think that's, that's probably the explanation. If you're a large investor, you know, big pension fund, big sovereign wealth fund, who do the co-invest, they're going into the mega funds because that's where they can put the money to work. That's, that's not an irrational thing for the, for the large investors. For somebody, I think for an endowment that's, you know, a $10 billion endowment, then maybe you, you want to go somewhere else for the, you know, if you're a hundred billion trillion dollar investor, then, then it makes perfect sense.

• 31:10David Weisburd?

  Is there a back of the napkin way to convert a 2 and 20 into a percentage, a annualized percentage?

• 31:19Speaker 01

  Uh, yes, there is. You, you have to tell me what the gross return is to turn it into net. Because that, as the gross return gets bigger, the spread gets bigger. So take a 25% gross, which would be a very nice fund, right? 25% gross is, you know, more or less 3X, 3X gross. The 3X gross, 25% gross turns into like 19 net. So that'd be a-

• 31:56David Weisburd?

  About a 6% annualized fee.

• 31:58Speaker 01

  Yep, 6% fees, absolutely.

• 32:00David Weisburd?

  Said another way, if the fund is doing a 19% and you were accessing co-invest, let's say that you weren't adversely selected, you would be, be getting another 6%.

• 32:09Speaker 01

  Correct.

• 32:09David Weisburd?

  So quite, so if you were going apples to apples to S and P 500, you were even now with the coinvest, you're 6%. Maybe if that's half of it, you're 3% if you have one.

• 32:19Speaker 01

  Correct, correct. And I think people say it's like coinvest like a quarter to 30%. So you take, you know, 30% of the 6% be 1.8%. That would be sort of industry wide.

• 32:35David Weisburd?

  So one of these memes in the market is large buyout because there's no, the leverage is not as attractive. Maybe there's the same access to leverage, but the interest rates are higher, is almost inferior to S and P 500. Small buyout, there's still like this operational value add that you could do and you could have multiple expansion, all these things. I'm asking you to project into the future, which is not something you typically do, but to what extent do you believe in that meme? And, and what are your thoughts on this?

• 33:05Speaker 01

  You've got mega, you've got middle market, you have lower middle market on the buyout side. All of them, I, I think have, have invested heavily in trying to add value to their companies. And I think that's, that's the, the big change over, you know, when I started. So I started teaching private equity in 1996 and I would, would regularly have people in class or I'd have, have GPs in class and I would, I had a framework as

• 33:44Speaker 01

  to, you know, how I evaluate deals. And one of the pieces of the framework is how do you improve the business? And then another piece of the framework is, is what's your, your edge or what's proprietary about you doing the deal rather than somebody else? And it was, I always, it was sort of bizarre. I like would ask, ask them that and then half the time they would say, well, what are you talking about? I don't do that. About thinking about why, what's my edge, or why am I doing the deal? And I thought, gee, that's, that's kind of weird. I would have thought of that's the first thing. Now I ask that question, it's the first thing they think about.

• 34:29Speaker 01

  So the world hugely changed that in 2000, that was a huge advantage if you did that. And I have, I have some, several former students who did that and are, you know, have very successful private equity funds. And now it's table stakes. So everybody's doing it. So the world is more competitive across all the asset classes, but they're all doing it. So the good news is when they buy a company, they're buying it with an idea, here's how I'm going to make it better. Now, the question is, can you make money doing that because you're competing? And so you're competing against other funds who are doing this.

• 35:11Speaker 01

  So that makes it harder to have excess return. So now let's look at the different parts of the market. The mega funds, the hardest part for them these days is exiting. Because they have, number one, it's hard to, if you've done a mega deal, it's hard to sell it to another private equity firm because the deal's too big. Um, strategics are tricky for antitrust reasons. So even though the, um, the administration has changed, it's not clear that antitrust is going to be a lot less tough. It'll be less tough, but, but there's still, you know, antitrust risk.

• 35:56Speaker 01

  You can go public, but going public is, is harder these days. Um, because there are fewer IPOs for whatever reason. And then once you do go public, it takes a long time to distribute because you're, you know, if you own 70, 80% of the company, it's, it's hard to, um, get all that out. And so, and then you've got continuation vehicles, which they're here because of uh, the difficulties in exiting, but it's still for the mega funds, it's still their very, very big check. So the mega funds, their, their real challenge is going to be figuring out how to exit deals at decent valuations. So I'm like, I'm a little nervous about the mega funds.

• 36:40Speaker 01

  For that reason, the middle market, I think, is better because they can sell in, they can sell to other private equity, they can sell more easily into the continuation vehicles, the strategics, probably less antitrust, and IPO, probably less traditional. And then the lower middle market, I think, is still the most attractive because there's a little less competition for deals. I think you can do more with the companies and it's a lot easier to exit. The problem with lower middle market, it's hard to put a huge money to work because the funds are half a billion as opposed to five billion. So that's how

• 37:18Speaker 01

  I view looking forward. I would say that the other thing that's positive about buyout is that the buyout funds, the GPs are still underwriting to 20, 25% IRRs to two and a half, three times gross. And so even if they don't, you know, they do the deal, they don't hit that number, the returns are still likely to be okay. So I like the risk return on buyout in general and skewed a little bit toward, you know, away from the megs.

• 38:00David Weisburd?

  You've been teaching private equity since 1996. Obviously, you've had students and you're like, oh, I think he's going to be very successful and he was not successful. Maybe she was not supposed to be very successful, she was successful. What characteristics do you find that in retrospect, what are some of the patterns that you find in retrospect among your students that are predictive of them being successful in private equity?

• 38:22Speaker 01

  How you do in my course is a very good predictor. And the reason, and I can tell you, the people who have been very successful private equity investors, not exclusively, but with a high correlation, did well in my course. And I'll tell you why. Number one, my course, it's a case course, venture capital and buyout. And half your grade is class participation, half your grade is a final. So to do well on the final, there are really two pieces of the final usually. There's, there's like a, an analytical numbers part.

• 39:07Speaker 01

  And then there's a big picture, like, do you get the, the economics, the big picture? To do really well on the final, you gotta see the big picture and you have to be able to do the numbers. Well, those are pretty important to being a good investor, right? Got to get the numbers right, but you gotta see the big picture. Then on the class participation, to do well there, you have to, you know, have a couple of things. First, you have to be aggressive. So you have to raise your hand and get out there. Second of all, you, you have to be articulate and be able to explain what you're thinking.

• 39:52Speaker 01

  And I think that is also very useful for private equity because you've got to be able to explain what you're doing to management teams and to LPs. So if you have, you know, those, those characteristics, you're aggressive, you're articulate, you can do the numbers and see the big picture. Um, those are, those are four pretty good, pretty good characteristics.

• 40:21David Weisburd?

  When we last chatted, you mentioned that when people are scared to invest in private equity, it's the best time to invest. Outside of the obvious supply and demand dynamics, tell me how that's actually plays out in the market.

• 40:35Speaker 01

  I'm gonna, gonna caveat this, that it's, it's, it's hard to know when you're exactly at a peak. And I, and I wrote a paper on this, um, saying that, that at the time, you can't always tell. But when you are at a period like,

• 40:56Speaker 01

  2000 in venture, the amount of money in venture was crazy. That was not a good time to invest in venture. The vintages in buyout that have been sort of the mediocre performers, 06, 07, 08, those vintages are, you know, S and P like slightly better. That's when a lot of money was going in. And 2020, 21 as well, a lot of money went in. It was, you know, a big pickup and those vintages, um, you know, as we saw are not looking so great.

• 41:34Speaker 01

  And then, you know, on the venture side, um, you had people in, in 09, you know, saying the venture, venture capital was dead. It's never going to go anywhere and, you know, those vintages were awesome. You know, 09 to, to 2013 or 14 on venture. And, uh, you know, buyout people thought was dead in 02 to 04. They thought it was dead in, you know, 2010 to 2014. So, so you have these, these periods where a lot of money is going in. And particularly after a couple of years, when a lot of money has gone in,

• 42:16Speaker 01

  those are vintages that are historically not good. And then on the flip side, vintages where there's not a lot of money going in, uh, have turned out to be, to be good vintages. And, and as it, you know, that looks to me like supply and demand. And again, it's not perfect because venture like in 97, 98, was higher than it was in the previous years. And so those vintages actually turned out to be very good. But then the next couple of years was an amazing amount of money. Those were the bad vintages. So it's, it's not.

• 42:57Speaker 01

  It's not perfect because you can't always tell exactly where you are on the curve. And we're, by the way, at a period where, um, you know, the buyout is actually down a little bit relative to the last few years. Um, and ventures, ventures down a little bit too. So, you know, to your point, I think earlier, you know, you had the 2021 stuff that was very, people did deals they shouldn't have done. There's this indigestion period. We're kind of in a period where people are, are being mixed or a little negative. And that may continue if the, the marks that we see, if, you know, when they start selling,

• 43:39Speaker 01

  they, they, um, those valuations come down a little bit. So it'll be very interesting to see whether, uh, whether that's predictive or not.

• 43:50David Weisburd?

  It's easy to see when something's overheated and goes down because you see the withdrawal. It's harder to predict when something's at the top until after, because sometimes there's this bull run. But to your point, if something keeps on compounding by, let's say, a TAM of 20, 30% for many years, you could predict that maybe it won't go down next year. It'll go down in the next couple of years. Although that's also difficult because venture had this bull run from 2008 to 2021, essentially.

• 44:17Speaker 01

  If it were easy, if it were easy, you know, I'd be running a hedge fund. What I would do, yo, in, in this is rather than, than riding up and down, just sort of keep your allocations constant over time. I mean, that's the, that's the way to sort of, you'll, you'll put a little bit more to work in the,

• 44:41Speaker 01

  in the bad year, in the low years, you put a little bit less to work in the overheated years.

• 44:47David Weisburd?

  The analogy is if you want to be top decile, you, you pick the, the bull in the bear markets, which you could argue it's possible or not possible, probably closer to impossible. But if you want to be top quartile, you just stay in the market. You just keep on investing and that's the investors that's done really well. One of the most absurd ideas to me on this private equity or venture capital is there seems to be this assumption that you have to invest in a certain valuation. So if I'm investing in venture seed, it has to be at 20 million versus this much more real dynamic, which is supply and demand. So if venture is very unfavorable, you're investing at a lower valuation. So clearly at some valuation, it makes sense to invest in venture. So it's not a question of whether it's it's good to invest in venture or not.

• 45:32David Weisburd?

  It's whether there's more good opportunities in capital that is chasing it at the time. In other words, it's not whether it's a good year, a bad year to start a tech company. It's whether other people believe that and kind of the game theory between other investors in the market.

• 45:46Speaker 01

  Look, if you if you invest in the same deal at a 5 million valuation versus 50, your returns are going to be a lot different.

• 45:55David Weisburd?

  I can't let you go without asking you about to normalize the data for venture against S and P 500 over the last several decades based on LP data, not based on GP data.

• 46:05Speaker 01

  So I didn't say something earlier that that's well worth saying. There's some some new research that uses data from Adipar. And Adipar basically is a platform for family offices and wealthy individuals who invest in a lot of funds. And what the Adipar data show is almost identical to the Burgess data. So the good news on that, there's two pieces of good news on that for your the people listening is number one, the the Burgess data seem right. Adipar, it's a different sample. It's family offices, wealthy individuals.

• 46:51Speaker 01

  The returns that I just told you and I'm and will tell you are basically the same in Adipar and Burgess. That's one. Two, it seems like the family offices and wealthy individuals are getting into the same types of funds. So you're not adversely selected versus the institutions what the family offices and wealthy individuals get into. So if you're going to do this, that's that's good news. Venture is much more variable than the buy outside. So venture has had periods where it's well outperformed the S and P 500,

• 47:34Speaker 01

  and it's had periods where it hasn't. And so if you look at, for example, 2009 to 2017 vintages, venture did spectacularly. The average PME is like 1.25, 1.3 versus the 1.15 or so for buyout. On the other hand, 2020 to 22 vintages, they're underperforming the S and P 500 by quite a bit.

• 48:16Speaker 01

  PMEs are about 0.8 or 20% worse than the S and P 500. And of course, you had the mid to late 90s. The venture was amazing because of the dot com boom. And then you had 99 to 2006 where performance was terrible because of the dot com bust. So venture is much more variable by vintagier than buyout's been. Buyout's been very consistent. It's still over time beaten the S and P 500, but a lot more variation. And then the other thing that's a question mark with venture,

• 48:57Speaker 01

  at least among the academics, is that the beta of venture funds is a good deal greater than one. So you have to decide if you're an investor, you know, do you care? Like, some people will say, If you think that the beta is a lot bigger than one and then you compare that that return to venture, then the P M E adjusted for the beta actually doesn't look so good. On the other hand, if you're just, if you say, okay, I I'm just comparing it to the S and P 500. That's my benchmark, then it looks good.

• 49:40Speaker 01

  So I think that's a venture is a trickier asset class in that regard than buyout. I would add, funny enough, venture, I think, does give you some diversification benefit because it performs well at different periods. Like I just said, venture didn't perform very well 2020 to 25. The S and P went up and so venture has, you know, does perform differently from the S and P 500.

• 50:08David Weisburd?

  And that's, that's the entire venture asset class. So that is the mean return for venture.

• 50:15Speaker 01

  That's mean. And so you also have to be careful on venture in that mean is not median. And so their median is lower. So there's a skew and buyout, the mean and median are pretty close. So in buyout, it's sort of you, the outliers, you know, it's more of a normal distribution. Let's say venture, they're, you know, this is the getting into the, the top funds matters. And getting the top funds are more predictable in venture. Buyout, it's very hard to predict who's going to be the top fund in any vintage year.

• 50:56Speaker 01

  Venture, it's, you know, the, the founders funds, the sequoias, the benchmarks have been consistent. And so venture, you know, you have to make sure you're getting access. Now that's the bad news. The good news is the add a par data. The returns are similar, which suggests that people do get into some of the good funds.

• 51:21David Weisburd?

  There's like a 52% persistence in venture. I believe that's a University of Chicago study, actually.

• 51:26Speaker 01

  It would have been my study, so.

• 51:28David Weisburd?

  So to quote you back to yourself, 52% of funds raised post 2000 had above median performance, some persistence, 32% had top quartile performance. So 32% persistence, 52% outperformance post 2000. Well, Steve, there's a lot more to unpack, but we'll have to leave it to another podcast. I appreciate you jumping on and sharing your wisdom.

• 51:57Speaker 01

  Great. It was a pleasure.

• 51:59David Weisburd?

  Thank you. Thanks for listening to my conversation. If you enjoyed this episode, please share with a friend. This helps us grow. Also provides the very best feedback when we review the episode's analytics. Thank you for your support.