Resources/Weekly Insights

Volume 14, Edition 13 | April 27 - May 3, 2025

An Alternative Opinion

Doug Walters, CFA

With equity markets giving investors some hope of calm this week, we take the opportunity to dip our toes into the alternatives space with a critique of private equity.

Contributed by Doug Walters, David Lemire, Max Berkovich, Matthew Johnson

Market jitters took a back seat this week as tough tariff talk continued to soften. While we enjoy the market reprieve, we caution anyone from trying to predict where sentiment swings from here. The future, as always, remains unknown, and preparation is far more important than prediction. As we await that uncertain future, we take advantage of this moment of calm, to touch on alternative investments.

“Alternatives” is a loaded term covering everything from private equity (PE), to hedge funds, to gold, to real estate and beyond. Once the domain of institutions and the ultra-wealthy, we’ve seen alternatives increasingly pushed down market to the mainstream. As evidence-based investors, we see the utility of some alternatives (like gold) in a diversified portfolio and are skeptical of others that seem to simply offer a more expense version of exposures available in public markets.

Today, we’ll focus on private equity – an investment strategy that focuses on taking ownership stakes in private companies, often through buyouts or venture capital.

The Many Costs of Alternatives

Investors give up a lot with private investments.

Transparency

Unlike stock ownership, PE investors will know the investment strategy but get little detail on specific investments or tactical decisions. Pricing is also opaque, with valuations reported quarterly and based on estimates rather than market prices. How do you vet an investment without details? Hmm.

Liquidity

PE funds are illiquid. It is not unusual to lock up capital for up to 10 years, with redemption limits designed to prevent mass exits. If investors all want out, they are out of luck. Unwinding a position can take many years. As big proponents of the value of opportunistic rebalancing, we see the illiquidity that comes with PE is a major handicap.

Risks

While alternative investments promise higher returns, they often come with increased risk due to leverage, complex strategies, and lack of transparency. Values don’t visibly move day to day since they are often priced only quarterly. But don’t mistake this for stability and lower risk.

Cost

Private equity is expensive. A study (Lim, 2024) shows the cost of the average buyout fund is around 7.9%. That is 26,000% higher than the expense ratio of an index fund like Vanguard’s S&P 500 ETF at 0.03%. That is a massive performance drag to overcome.

Is the Performance Worth It?

The hope as an investor is that the above downsides are outweighed by higher performance. But that doesn’t seem to be the case. Of all the alternative asset classes, private equity does have one of the better records of outperformance. One study (Kaplan, 2023) found that PE generated cumulative returns about 20% greater than the stock market over the life of the fund. Another (Phalippou, 2023) found no performance advantage for PE. On the face, these seems good (or neutral) results, but the risk taken, in the form of leverage would imply that PE returns should have been much higher.

Underlining the above point, another study (Stafford, 2017) shows that private equity returns can be bested by replicating a typical strategy with public securities. A portfolio of small, low EBITDA multiple stocks with modest leverage represents “an economically large improvement in risk- and liquidity-adjusted returns over direct allocations to private equity funds, which charge estimated fees of 3.5% to 5% annually.”

Said more simply… if you’re willing to take the risk associated with PE, you can get better returns through public markets, without all the transparency and liquidity issues.

Are we saying all PE funds are bad? Of course not. There will always be outperformers. In the world of private funds, those outperformers are likely either anomalies, which you cannot reliably pick, or have exceptional management, with very limited access to outsiders.

We’ve only scratched the surface of alternatives today. While we see some uses for specialized assets like gold, the benefits of traditional alternatives like private equity are much more elusive to our evidence-demanding minds. As alternatives become more accessible to investors, it appears, for the time being, that the primary winners are those collecting the fees, not those taking the risk.

Lim, W. 2024. “Accessing Private Markets: What Does It Cost?” Financial Analysts Journal.

Kaplan, S.N. 2023. “Private Equity: Past, Present and Future.” Testimony before SEC Investor Advisory Committee.

Phalippou, L. 2023. “Private Equity Laid Bare, Version 3.” Independently published: www.pelaidbare.com.

Stafford. 2017. “Replicating Private Equity with Value Investing, Homemade Leverage, and Hold-to-Maturity Accounting” Harvard Business School.

2.3%

March PCE Inflation

March inflation came in a bit higher than expected at 2.3%, but lower than the previous 2.7%. While down, these numbers do not yet reflect any tariff driven increases which would be further down the road.

Headline of the Week

Balls and Strikes with the Economy

With a tariff induced trade war and shrinking GDP numbers, the economy seemed like a baseball batter facing an 0-2 count with this month’s jobs report shaping up to be a nasty curveball. Fortunately, the solid job gains and steady unemployment figures seemed more like a hanging curve and markets welcomed the fat pitch over the middle, posting solid gains after the report. Given the continuing economic challenges emanating from tariffs and global trade, this one “hit” seems unlikely to turn the tide and lead to long rally. Resolving the trade issues and reasserting more clarity out of Washington seems a more likely catalyst to putting more runs on the board.

*Sorry, that’s a lot of baseball references.

The Week Ahead

A services related survey is the last bit of economic data before the Federal Reserve gathers to make a rate decision. The Bank of England will make one as well a day later.

Services rendered

With the Gross Domestic Product, PCE Inflation and Jobs report in the rearview, the only significant economic print before the May rate decision is the Institute of Supply Management services Purchasing Managers Index (PMI).

With services being over 70% of the U.S. economy the PMI is a major data point.
A reading above 50 is expansionary and below contractionary.
The reading has stayed above 50 since last June but has steadily moved down so far this year.
The April reading is expected to decrease slightly but remain in expansion.

I’m still standing…

Especially after better-than-expected Friday’s jobs report, expectations for a rate cut have dried up for this meeting. The focus now moves to what about June?

July seems to be on the table still, with even June now unlikely.
Chairman Powell will ask for patience as the central bank looks for clear evidence that cuts are necessary, however, markets tend to not receive that message well and want more certainty.

On the move

Unlike the Federal Reserve the Bank of England (BoE) is expected to cut by ¼ of a percent.

The dovish BoE is still expected to cut 2 more times this year.
The cut next week is expected to be unanimous 9-0 with a rumored member to advocate for a bigger cut.
BoE has set a cadence of cutting every other meeting as well.

May the Fourth

Sunday is May the fourth, a special day for some. If you are celebrating, have an extra Corellian ale for me.

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