Private Equity’s Profit Charade

In my previous post, I explained why investments in private equity firms that buy and manage companies with the intent of changing them so they can be sold for a profit are especially risky. Those risks are ultimately being borne by a large segment of the population because public pension management institutions that hold the pension funds of public schoolteachers and other state workers are often large investors in private equity. 

Yet, as I also pointed out, those high risks might be justified if the returns from investments in private equity were especially large. But are they?

Private equity emerged as a substantial part of financial activity in the last quarter of the 20^th century. By early in the 21^st century, private equity was widely viewed as obtaining high returns. A 2007 article in the Harvard Business Review, attributed the seemingly high returns to: “high-powered incentives both for private equity portfolio managers and for the operating managers of businesses in the portfolio; the aggressive use of debt, which provides financing and tax advantages; a determined focus on cash flow and margin improvement; and freedom from restrictive public company regulations.” 

The author might have simply cited the last item, the “freedom” from regulation, which made the other practices possible. But, however explained, there is the question of how real the private equity profits have actually been. 

In 2005, a study reported in the Journal of Finance had called the high rates of private equity returns into question: “Average fund returns (net of fees) approximately equal the S&P 500 although substantial heterogeneity across funds exists.” The crucial words are in that parenthesis: “net of fees.” Because private equity firms charge very high fees, returns net of fees (the returns to the outside investors), on average were approximately equal to the returns of publicly traded companies listed on the S&P 500. In general, investments in these publicly traded companies involve neither as much risk nor as high fees as do investments in private equity firms.

More recently, a 2024 working paper from the Harvard Business School argued that, “the recent median PE [private equity] investments do not outperform PMEs [public market equivalents] …[and] PE performance may actually underperform PMEs on a risk adjusted basis given the amount of leverage [the PE firms] employ.”

Whatever criticisms of these studies might be raised, it is not clear that private equity investments outperform the options for the outside investors and creditors that finance private equity’s purchases of companies. There are, moreover, substantial difficulties in obtaining the relevant data. The authors of the Journal of Finance article state: “One of the main obstacles [of obtaining a clear understanding of private equity returns, capital flows, and their interrelation] has been the lack of available data. Private equity, as the name suggests, is largely exempt from public disclosure requirements.”  

Another important factor confounding efforts to determine the returns in private equity is the way the value of unsold assets is calculated. Investors providing money to a private equity firm must leave their money with the firm for several years. During that time, the firm might sell some of the companies it has purchased, and the value of those sales is clear. However, as Eileen Applebaum points out in a 2022 article:

…in the years before the fund [the particular fund in which the private equity firm holds particular companies] reaches the end of its life span, typically 10 years, the fund manager … provides “guesstimates” of what these companies are worth. These estimates may be optimistically high, thus inflating the fund’s value and exaggerating its performance until the fund reaches the end of its life span and cashes out entirely. Only then will the fund’s investors learn what the fund actually earned and how it performed.

The guesstimates of the value of the fund’s unsold inventory form the basis for the myth of PE funds’ strong performance… 

Available data do not tell us how large a share of private equity is made up of these “guesstimates.” Appelbaum does provide data for 2009 through 2016 for CalPERS, the very large California state employees’ pension fund. These data show that for CalPERS’s private equity holdings:  

The unsold portion of the total value averages 47 percent for vintage years that are between 6 and 13-years-old. The 2009 vintage still [in 2022] has 45 percent of its value tied up in companies sitting on its shelf, whose value is largely a guesstimate by PE fund managers… More recent vintages have much higher proportions of unsold inventory, … with the 2016 vintage with 71 percent unsold.” [“Vintage” refers to the year private equity investments were made by CalPERS.] 

Similar data are provided in a May 2024 article in the Financial Times, which notes that: “Private capital firms have taken in more money from investors than they’ve distributed back to them in gains for six straight years, for a total gap of $1.56 trillion over that period [emphasis in original].”

It is conceivable that in a growing industry, for a given period more money will be taken in than is paid out. However, while not as large, for the period 2011 through September 2023, the gap of money coming in over payments going out was $0.6 trillion. In any case, the persistence of this gap over several years confirms that pension funds investing in private equity firms must rely a great deal on the “guesstimates” provided by the firms to determine their returns.

These data on the failure of private equity firms to exit many of their investments also points to the recent and continuing difficulties of the private equity industry. Again, the issue is pointed out by Appelbaum in a June 2025 piece: 

The private equity industry is underperforming, cannot exit its investments, and cannot return much actual cash to its institutional investors—in large part because the industry since 2022 has consistently overvalued their portfolio companies. Private equity investors are clamoring for cash, and the 401(k)s and IRAs look like just the perfect bailout for the PE billionaires. And the Trump administration is geared to help them—along with other industries like hedge funds and cryptocurrency—at the expense of ordinary workers’ retirement accounts. 

As I noted at the beginning of part one of this series, President Donald Trump has done just that.

A Final Comment

As bad as the financial shenanigans of private equity and cooperating public pension fund managers are, there is another aspect of private equity that is perhaps worse—the direct social damage private equity firms generate.

The recent debacle with Steward Health Care hospitals in Massachusetts (described in part one of this series) has exposed the extremely negative aspects of some private investment activity. The Steward group of hospitals was owned by private equity firm Cerberus Capital Management from 2010 to 2020, and this firm followed practices that appear to have led to poor services, possibly resulting in the deaths of some patients, while, it seems, extracting huge fees for Cerberus and its executives. Moreover, Steward’s declaration of bankruptcy in 2024 forced the closing of some hospitals vital to health care in areas of Massachusetts.

The experience of Steward is not unique. Problems have arisen in private equity-owned medical facilities elsewhere in the country. Also, other areas of private equity have performed poorly and caused social damage in other lines of activity.  Nursing homes, prisons, and public housing provide examples. And there is also the issue of union busting.

There are a common threads tying together many activities where the socially damaging actions by private equity firms have been acute. They are often activities where competition is very limited and the affected population has limited power (people who are incarcerated and those in public housing). Or those affected are not in a good condition to act in response to poor services (hospitals and nursing homes). However, private equity’s bleeding of companies has also led to the bankruptcy of companies not characterized by these vulnerabilities. The experience of Toys “R” Us is one example.

In all of these cases, vulnerable people have been harmed or people have lost their jobs or both. Society has been damaged, while some individuals have become very rich. Such is the story of private equity.

Arthur MacEwan is professor emeritus of economics at the University of Massachusetts Boston.