Abstract
Private equity (PE) involves the acquisition of stock market listed or private companies, typically through funds managed by specialized firms, with the aim of increasing the companies’ value over a number of years before eventually selling them to realize returns for investors. PE rose to prominence in the 1980s, when high-profile leveraged buyouts, financed by the high-yield junk bonds pioneered by Michael Milken at investment bank Drexel Burnham Lambert, targeted multi-billion-dollar companies, such as RJR Nabisco, Federated Department Stores, and Beatrice Companies. Today, PE has grown into a sizable asset class, with $3.3 trillion in worldwide assets under management as of 2022. Most foundations and university endowments (88%, according to a 2017 survey of 41 firms) are invested in private equity, as are many other institutional investors. Yale University, long a pioneer of alternative asset class investment, currently allocates 17.5% of its endowment to private equity, and the Virginia Retirement System allocates even more (33%). Private equity is an intermediated asset class: Asset owners, such as endowments or pension plans, invest capital in private equity funds that in turn buy companies, own them for a number of years, then sell them and distribute the proceeds to their investors. How well asset owners fare when they entrust their capital to private equity fund managers depends on the managers’ ability to select suitable companies for investment; their ability to help their portfolio companies grow, become more efficient, and innovate; and their ability to exit the companies at attractive valuations. How well asset owners fare also depends on how well aligned fund managers’ interests are with those of their investors. In this review, I will critically synthesize the main insights of more than 80 academic studies of private equity, with a special focus on the performance of private equity as an asset class and its track record of value creation. I will also focus on the key aspects of investing in private equity that are relevant to investors in private equity funds.