The quest for superior alpha creation is a constant in investing, shaped by the dynamics of risk and reward. At the heart of this journey lies a comparison between two distinct models: Private investing and Public Companies. Each operates within unique frameworks, guided by differing strategic imperatives and economic incentives.
Over the past years, I’ve delved into the complex narrative of when and why private equity (PE) firms outperform or lag behind their public counterparts. This analysis dissects the circumstances under which private equity shines or falls short, linking these outcomes to root causes inherent in both scenarios. It beckons a deep dive into the operational, strategic, and market-driven factors shaping PE investment outcomes, offering a balanced perspective on the advantages leveraged and the obstacles faced.
As we embark on this examination, it's crucial to consider the evolving landscape of global finance, where the distinction between private and public investment is increasingly blurred by macroeconomic trends, regulatory changes, and the relentless pace of innovation.
Private equity (PE) firms operate fundamentally differently than public companies, leveraging specific strategies and advantages that can lead to superior performance, growth, and operational efficiency. After decades working on both sides of the equation, here are key observations on how PE can outperform public companies:
Private equity firms are known for actively managing their portfolio companies, implementing swift efficiency improvements. This hands-on approach can lead to significant value creation, particularly when combined with a culture that prioritizes speed-to-outcome and accountability.
A Harvard Business School study, "Private Equity and Industry Performance," found that industries with heavy PE investment showed improved productivity gains post-investment.
Unlike public companies, pressured to meet quarterly earnings targets, PE firms can focus on long-term alpha (excess risk-adjusted value creation). This allows investments in strategic initiatives that may not pay off immediately but generate significant returns over time.
The 2020 McKinsey Global Private Markets Review noted that private markets, including PE, outperformed in growth, with private market assets under management increasing from $2 trillion in 2000 to $6.5 trillion in 2018, indicating a successful long-term growth strategy.
PE aligns management interests with those of entrepreneurs and investors through significant performance-based incentives, often linking compensation to company success. This alignment drives stronger performance and reduces friction.
A study by the Journal of Finance, "Private Equity Performance: Returns,Persistence, and Capital Flows," indicates that this incentive alignment contributes to higher returns compared to public markets.
PE firm scan make decisions quickly, without needing public shareholder approval or navigating extensive middle management. This agility allows them to capitalize on opportunities more rapidly and pivot strategies as needed.
TheBoston Consulting Group (BCG) highlighted in their report on private equity that the ability to act swiftly and decisively is crucial for PE investment success, particularly in rapidly changing markets
PE can provide substantial capital to fund growth initiatives, acquisitions, or restructuring without the constraints and dilution of public equity offerings. PE's demand for high ROI ensures a focused strategy, funding only actions with significant ROI. In contrast, public companies often fund a broader array of projects that may not be essential or high ROI.
The Global Private Equity Report by Bain& Company highlighted that PE continues to have strong access to capital, with record levels of dry powder (uninvested capital) available to fund new opportunities. This trend is evolving with higher risks and costs of capital, but it seems likely to prevail.
PE firms excel at identifying, acquiring, and integrating companies to drive synergies and growth. They often employ a buy-and-build strategy, consolidating markets to create more valuable entities. In our own Operating Partner teams, we demanded full integration of assets in 3-6 months, whereas public companies could plan multi-year integrations and research shows the duration the “patient is open” directly correlates to the probability of long-term success.
A McKinsey report on private equity's role in mergers and acquisitions noted that PE-backed companies are better positioned to execute successful M&A strategies, often leading to higher returns in a faster cadence.
It's important to note that while PE offers these advantages, outcomes vary widely among firms and individual investments. Performance also depends on market conditions, specific strategies, and management teams.
In the high-octane world of investment, private equity (PE) stands out for its ambition to deliver outsized returns. However, risks and limitations may temper these financial triumphs over the long haul.
The Roosevelt Institute highlighted a conundrum: while PE can engineer immediate profit spikes through rigorous cost-cutting, these tactics may erode a company’s long-term growth engines and employee morale. The focus on short-term improvements and expensive debt can leave firms underinvested in brand equity, innovation, and digital disruption, reducing value beyond the PE firm’s investment lifecycle.
Harvard Business Review warns that PE's heavy debt strategy can lead to defaults during economic downturns, eating into long-term value. The industry has overly focused on financial engineering, needing equal emphasis on operational renewal to thrive in the new economy.
With less rigorous disclosure requirements, PE’s true performance can be murky. TheNational Bureau of Economic Research cites issues like 'appraisal smoothing,'which can disguise the real risk and return scenario. In reality, part of PE’s performance is beta dressed as alpha. In the upcoming economy, with higher regulatory and governance scrutiny, it’s imperative for the industry to manage risk-weighted returns actively.
Bain Global Private Equity Report highlights timing risks: buy high or sell low, and PE magic dwindles. Market cycles are merciless and closed end timeframes of the industry can have PE funds diving in to sectors during market highs chasing the returns that better-timed funds achieve.
Examining Private Equity (PE) versus Public Companies reveals a complex landscape where strategic agility, operational efficiency, and incentive alignment play critical roles. This article aims not to pick a winner but to consider the strengths and weaknesses in each model, charting a path for the Private Investing firm of the future.
For investors, navigating the PE landscape requires vigilance and discernment, understanding the underlying factors influencing performance. In other whitepapers, we explore what must be protected, what must change in private investing, and share "postcards from the future" where deeper operational rigor meets the disruptive forces of AI and Digital to create the NextGen private investing firm that can perform with “all weather”capabilities.
The quest for superior alpha creation is a constant in investing, shaped by the dynamics of risk and reward. At the heart of this journey lies a comparison between two distinct models: Private investing and Public Companies. Each operates within unique frameworks, guided by differing strategic imperatives and economic incentives.
Over the past years, I’ve delved into the complex narrative of when and why private equity (PE) firms outperform or lag behind their public counterparts. This analysis dissects the circumstances under which private equity shines or falls short, linking these outcomes to root causes inherent in both scenarios. It beckons a deep dive into the operational, strategic, and market-driven factors shaping PE investment outcomes, offering a balanced perspective on the advantages leveraged and the obstacles faced.
As we embark on this examination, it's crucial to consider the evolving landscape of global finance, where the distinction between private and public investment is increasingly blurred by macroeconomic trends, regulatory changes, and the relentless pace of innovation.
Private equity (PE) firms operate fundamentally differently than public companies, leveraging specific strategies and advantages that can lead to superior performance, growth, and operational efficiency. After decades working on both sides of the equation, here are key observations on how PE can outperform public companies:
Private equity firms are known for actively managing their portfolio companies, implementing swift efficiency improvements. This hands-on approach can lead to significant value creation, particularly when combined with a culture that prioritizes speed-to-outcome and accountability.
A Harvard Business School study, "Private Equity and Industry Performance," found that industries with heavy PE investment showed improved productivity gains post-investment.
Unlike public companies, pressured to meet quarterly earnings targets, PE firms can focus on long-term alpha (excess risk-adjusted value creation). This allows investments in strategic initiatives that may not pay off immediately but generate significant returns over time.
The 2020 McKinsey Global Private Markets Review noted that private markets, including PE, outperformed in growth, with private market assets under management increasing from $2 trillion in 2000 to $6.5 trillion in 2018, indicating a successful long-term growth strategy.
PE aligns management interests with those of entrepreneurs and investors through significant performance-based incentives, often linking compensation to company success. This alignment drives stronger performance and reduces friction.
A study by the Journal of Finance, "Private Equity Performance: Returns,Persistence, and Capital Flows," indicates that this incentive alignment contributes to higher returns compared to public markets.
PE firm scan make decisions quickly, without needing public shareholder approval or navigating extensive middle management. This agility allows them to capitalize on opportunities more rapidly and pivot strategies as needed.
TheBoston Consulting Group (BCG) highlighted in their report on private equity that the ability to act swiftly and decisively is crucial for PE investment success, particularly in rapidly changing markets
PE can provide substantial capital to fund growth initiatives, acquisitions, or restructuring without the constraints and dilution of public equity offerings. PE's demand for high ROI ensures a focused strategy, funding only actions with significant ROI. In contrast, public companies often fund a broader array of projects that may not be essential or high ROI.
The Global Private Equity Report by Bain& Company highlighted that PE continues to have strong access to capital, with record levels of dry powder (uninvested capital) available to fund new opportunities. This trend is evolving with higher risks and costs of capital, but it seems likely to prevail.
PE firms excel at identifying, acquiring, and integrating companies to drive synergies and growth. They often employ a buy-and-build strategy, consolidating markets to create more valuable entities. In our own Operating Partner teams, we demanded full integration of assets in 3-6 months, whereas public companies could plan multi-year integrations and research shows the duration the “patient is open” directly correlates to the probability of long-term success.
A McKinsey report on private equity's role in mergers and acquisitions noted that PE-backed companies are better positioned to execute successful M&A strategies, often leading to higher returns in a faster cadence.
It's important to note that while PE offers these advantages, outcomes vary widely among firms and individual investments. Performance also depends on market conditions, specific strategies, and management teams.
In the high-octane world of investment, private equity (PE) stands out for its ambition to deliver outsized returns. However, risks and limitations may temper these financial triumphs over the long haul.
The Roosevelt Institute highlighted a conundrum: while PE can engineer immediate profit spikes through rigorous cost-cutting, these tactics may erode a company’s long-term growth engines and employee morale. The focus on short-term improvements and expensive debt can leave firms underinvested in brand equity, innovation, and digital disruption, reducing value beyond the PE firm’s investment lifecycle.
Harvard Business Review warns that PE's heavy debt strategy can lead to defaults during economic downturns, eating into long-term value. The industry has overly focused on financial engineering, needing equal emphasis on operational renewal to thrive in the new economy.
With less rigorous disclosure requirements, PE’s true performance can be murky. TheNational Bureau of Economic Research cites issues like 'appraisal smoothing,'which can disguise the real risk and return scenario. In reality, part of PE’s performance is beta dressed as alpha. In the upcoming economy, with higher regulatory and governance scrutiny, it’s imperative for the industry to manage risk-weighted returns actively.
Bain Global Private Equity Report highlights timing risks: buy high or sell low, and PE magic dwindles. Market cycles are merciless and closed end timeframes of the industry can have PE funds diving in to sectors during market highs chasing the returns that better-timed funds achieve.
Examining Private Equity (PE) versus Public Companies reveals a complex landscape where strategic agility, operational efficiency, and incentive alignment play critical roles. This article aims not to pick a winner but to consider the strengths and weaknesses in each model, charting a path for the Private Investing firm of the future.
For investors, navigating the PE landscape requires vigilance and discernment, understanding the underlying factors influencing performance. In other whitepapers, we explore what must be protected, what must change in private investing, and share "postcards from the future" where deeper operational rigor meets the disruptive forces of AI and Digital to create the NextGen private investing firm that can perform with “all weather”capabilities.
