In Part 1, we looked at why private equity can appear less risky than listed shares. Part of that difference comes from the way private investments are valued. Unlike listed shares, their prices are not changing on a stock exchange every day.

But investors don't choose private equity simply because its reported prices appear more stable. One of the main attractions has always been the possibility of earning higher returns. That raises an obvious question: if investors are expected to lock up their money for years and accept less liquidity, have they actually been rewarded with better returns?

Historically, the answer has generally been yes, particularly for private-equity buyout funds. But there is more to the comparison than putting a private-equity return beside the S&P 500 and seeing which number is higher.

Private equity has a good historical record

There is solid evidence that private equity has performed well over long periods. One of the better-known studies, by Robert Harris, Tim Jenkinson and Steven Kaplan, examined almost 1,400 US private-equity funds using actual cash flows from institutional investors. The researchers found that buyout funds generally outperformed public markets across much of the period they studied.

However, knowing that private equity performed better is only the starting point. We also need to understand where those returns came from, because not all of the additional return necessarily comes from a manager being better at picking or running companies.

Borrowing can increase the return

One important feature of private equity is the use of debt. When a private-equity fund buys a company, it does not necessarily pay for the entire company using investors' money.

Take a simplified example. A company is bought for $100. Instead of putting in the full $100, the private-equity fund uses $40 of investors' money and borrows the remaining $60.

A few years later, suppose the company is worth $120. The value of the company has risen by 20%. If we assume for simplicity that the debt is still $60, the investors' portion is now worth $60. Their original $40 has become $60, which is a 50% increase.

This is leverage. Borrowing magnifies the return earned on the investors' own capital.

It can be very effective when the investment performs well, but the same effect works in reverse. If the value of the company falls, the debt still has to be repaid and the investors can suffer a much larger percentage loss on their own capital.

This is why a higher private-equity return should not automatically be interpreted as evidence of superior investment skill. Some of the return may come from improving the underlying business, while some may come from taking more financial risk through borrowing.

Be careful when comparing the return numbers

There is another complication. Private equity and public-market investments don't always report performance in the same way.

Private-equity funds commonly use Internal Rate of Return, or IRR. IRR takes into account not only how much money an investor receives, but also when the money is invested and returned. Returning money earlier can therefore improve the IRR.

This is useful because timing does matter. Receiving $100 today is clearly more valuable than receiving the same $100 several years from now. The problem arises when an investor sees, for example, a 15% private-equity IRR and compares it directly with a 10% annual return from a stock-market index. The two figures are not necessarily measuring performance on exactly the same basis.

Researchers therefore also use measures such as Public Market Equivalent, or PME. Despite the technical name, the idea is fairly simple. PME asks what would have happened if the money going into and coming out of the private-equity fund had instead been invested in a public-market index at the same times.

If the private-equity investment still comes out ahead after making the comparison this way, there is stronger evidence that it really did outperform the public market.

For most investors, there is no need to understand the mathematics behind PME. The useful lesson is simply that headline return numbers need to be compared on a like-for-like basis.

Which private-equity manager?

Even if private equity as an asset class has performed well historically, an investor cannot actually buy the historical average. The money has to go into a particular fund run by a particular manager.

This matters because the difference between private-equity managers can be substantial. A strong manager may buy companies at sensible prices, improve their operations and sell them successfully. Another manager investing during the same period may produce a very different result.

This is quite different from buying a broad-market index fund. With an index fund, the intention is to earn something close to the market return. With private equity, the choice of manager can have a much greater influence on the final outcome.

It also creates a practical problem. Looking back, it is easy to identify the managers that performed exceptionally well. The difficult part is identifying them before committing money for the next five or ten years.

So when someone says that top private-equity funds have produced very high returns, there is another question worth asking: how realistic is it for an ordinary investor to gain access to those funds and identify the better managers in advance?

Private equity does not outperform all the time

The historical record is strong, but private equity has not beaten public markets in every period.

This has been particularly clear in recent years. McKinsey's 2026 private-markets report estimates that buyout funds returned around 7% in 2025, compared with approximately 18% for the S&P 500 and 22% for MSCI World. It was the third consecutive year in which buyout funds lagged those public-market benchmarks.

That does not mean private equity has stopped working. Three years is a short period for an investment strategy in which companies may be held for many years, and today's private-equity returns also reflect investments made under very different market conditions.

Still, the recent results are useful because they challenge a common assumption: private equity does not automatically produce higher returns simply because the investments are private.

Market conditions matter. The price paid for a company matters. Interest rates and borrowing costs matter. The ability to improve the business matters. And eventually, the manager must be able to sell the investment at an attractive price.

The extra return needs to compensate for something

This brings us back to why investors expect private equity to produce higher returns in the first place.

With a listed investment, you can normally see its market price and sell it relatively easily. With private equity, your money may be tied up for many years. Fees can also be higher, valuations are less transparent, leverage may add risk, and the eventual result can depend heavily on the manager selected.

If private equity produces exactly the same return as a liquid public-market investment, an investor might reasonably ask why the additional restrictions and risks were worth accepting.

So simply beating the S&P 500 is not necessarily enough. The more useful question is whether the additional return is sufficient compensation for the additional risks, fees and loss of liquidity.

That is also why private equity should not be assessed purely on the highest historical return that can be found. Investors need to look at what they are giving up in exchange for the possibility of earning more.

Money & Macro Takeaway

Private equity has a strong historical record. Research shows that buyout funds have, over long periods, delivered returns above public markets. So the case for private equity is not built purely on marketing.

At the same time, the headline return does not tell the whole story. Leverage can increase returns, IRR needs to be interpreted carefully, results vary considerably between managers, and investors usually have to accept less liquidity and higher fees. Recent years have also shown that public markets can outperform private equity for extended periods.

For investors, the question therefore should not be simply whether private equity can beat public markets. It should be whether the potential additional return is worth what you have to give up to obtain it.

That distinction becomes even more important as private equity is increasingly being offered to individual investors. And it leads naturally to the final part of this series: if private equity comes with these trade-offs, why are investment companies so keen to make it available to a much wider group of investors?

Part 3: Why Are Asset Managers Offering More Private Equity to Individual Investors?

Private Equity series

Research sources

Money & Macro by NorthAxis

This post is for general educational purposes only and does not constitute financial advice or a recommendation to buy or sell any investment product. Investors should consider their own objectives, financial situation, and risk tolerance before making any investment decision.