On Private Equity

The entire private equity industry is built on a single, foundational lie.

It's a simple, seductive, and catastrophically wrong idea: that by giving a small cabal of hyper-aggressive, Patagonia-vest-wearing financiers a mountain of your capital and letting them lock it up for a decade, you will be rewarded with "superior, outsized returns". This premise, repeated like a mantra by General Partners (GPs), placement agents, and their well-paid lobbyists, has fueled one of the most significant and, frankly, most absurd reallocations of capital in modern history.

In the wreckage of the 2008 financial crisis, with interest rates nailed to the floor, institutional investors were desperate. Pension funds and endowments, staring down the barrel of impossible funding gaps, went hunting for yield like starving animals. And private equity was there, waiting with a slick pitch deck and a story. The story worked. Capital flooded into the asset class, increasing ten-fold. PE went from a "niche" strategy to a "core" part of every major portfolio.

The only problem? The story is bullshit.

A massive and consequential chasm exists between the industry's marketing materials and the cold, hard reality uncovered by rigorous academic research. While the industry pats itself on the back for delivering 15%+ returns, the academic evidence suggests the average PE fund is a fee-heavy, illiquid, and leveraged dog that can't even beat a simple public market index after you account for its ludicrous costs.

So let's pull back the curtain on this grift. Let's talk about how the sausage gets made, because it’s not pretty.

The Numbers Are Fake and The Metrics Are Garbage

To understand the private equity con, you first have to understand that their favorite performance metric, the Internal Rate of Return (IRR), is a statistical parlor trick.

IRR is the most cited number in any PE pitch book for one simple reason: it can be easily manipulated. The formula is hyper-sensitive to the timing of cash flows, meaning a small, quick profit early in a fund’s life can generate a sky-high IRR, even if the fund's total profit over a decade is pathetic. It’s a measure of speed, not value creation.

And GPs have gotten exceptionally good at goosing this number. The now-ubiquitous use of "subscription lines of credit" is a perfect example of this financial engineering nonsense. Instead of calling your capital when they buy a company, the GP borrows the money from a bank first, then calls your capital later to pay off the loan. This does absolutely nothing for you, the investor. It doesn't generate a single extra dollar of profit. But by artificially shortening the time your capital is "at work" in the IRR calculation, it mechanically inflates the final number, often by a full percentage point. It’s a lie. A pure, unadulterated, mathematical lie designed to look good in a marketing document.

The metric they don't want you to talk about is the Public Market Equivalent (PME). PME analysis answers the simple, brutal question that every Limited Partner (LP) should be asking: "Would I have been better off just putting this money in an S&P 500 index fund?". It’s the truth-teller, which is precisely why the industry prefers the easily manipulated IRR.

The Valuation Mirage: Marking Your Own Homework

So the headline metric is a joke. But it gets so much worse.

A huge portion of a PE fund's reported performance at any given time isn't cash. It's not realized returns. It's the "Net Asset Value" (NAV)—the supposed "fair value" of the companies still in the portfolio. And who determines that value? The General Partner, of course.

This is the equivalent of letting students grade their own exams. The conflict of interest is staggering. Management fees are often charged as a percentage of NAV, creating a direct incentive to never write down the value of a struggling asset.

But the real scam happens during fundraising. Academic research has found a clear, systematic pattern: when a GP is out raising their next, bigger fund, they strategically inflate the valuations of the assets in their current fund. This creates a rosy picture of interim performance that they use as a marketing tool to sucker in new LPs. And what happens after the new fund closes? Those inflated marks are quietly written back down. The LPs who committed capital based on those high interim returns were sold a bill of goods, relying on a signal that had zero predictive power for the fund's final, actual performance.

It’s not an accounting choice. It’s fraud.

The Great Persistence Collapse

"But what about the track record?" they’ll scream. "You have to invest with the winners!" This argument relies on something called "performance persistence"—the idea that a top-quartile manager in one fund is likely to be a top-quartile manager in the next.

And for a while, that was true. The leveraged buyout was a genuine financial innovation, and the managers who mastered it first consistently outperformed. But those days are long, long gone.

The post-2008 flood of capital changed everything. The LBO playbook got commoditized. Everyone knows how to pull the same financial levers. The result? A dramatic, statistically undeniable collapse in performance persistence for buyout funds.

Let me be clear: For any buyout fund launched after the year 2000, the quartile ranking of a GP's previous fund is now a statistically useless predictor of the current fund's performance. A top-quartile manager is now almost as likely to be followed by a bottom-quartile fund as another top-quartile one. The process of picking a winning buyout manager has become, in the words of academics, a "random walk".

Yet capital continues to pour into the same "brand name" mega-funds, not because they have any discernible edge, but because of institutional inertia and career risk. For a pension fund CIO, it's "safer" to give money to a giant, well-known firm and get mediocre results than to take a risk on a smaller manager. It's a failure of fiduciary duty, plain and simple.

So, What Are You Actually Buying?

This brings us to the ugliest truth of all. The industry sells you "alpha," a unique, skill-based return stream that you can't get anywhere else. But what are you actually getting?

You're getting expensive beta.

Academic research has shown that the return profile of the average PE buyout fund can be largely replicated by simply creating a public market portfolio with the same risk characteristics: a concentrated basket of highly levered, small-cap, value stocks. That's it. That’s the magic formula. You're not buying inimitable operational genius; you're buying a bundle of well-known public market risk factors.

The problem is you're paying an extortionate price for it. The typical "2-and-20" fee structure creates a massive drag on returns, estimated to be 5% to 6% per year. This fee load is so heavy it can turn gross outperformance into net underperformance for the investor. You're paying active management fees for a passive risk exposure you could replicate with ETFs for a tiny fraction of the cost.

The Verdict

Let's put this all together. The private equity industry is a fee-harvesting machine that has mastered the art of marketing.

1. It uses a flawed, easily manipulated metric (IRR) to present a flattering picture of performance.
2. It relies on self-reported, strategically inflated valuations that have no bearing on final cash returns.
3. Its historical argument for skill, performance persistence, has completely collapsed in the modern era.
4. A huge chunk of its supposed "alpha" is just expensive, repackaged public market beta.
5. All of this is before you subtract the crippling 5-6% annual fee drag that erodes most, if not all, of the potential premium.

For the median investor allocating to the median fund, private equity has become an expensive, illiquid, and highly levered version of the public markets. The premium is not a given; it is an elusive prize that almost no one captures. The burden of proof is now squarely on the GPs to demonstrate their value, and based on the evidence, they are failing miserably. Don't believe the hype.