The ostensibly high profits of private equity have been ascribed to “freedom” from regulation. However, the question remains as to how genuine the private equity earnings have been.
I discussed why it is particularly risky to invest in private equity firms that purchase and manage businesses with the goal of transforming them so they can be sold for a profit in my earlier post. Since public pension management organizations, which retain the pension funds of public schoolteachers and other state employees, are frequently significant investors in private equity, a sizable portion of the populace is ultimately bearing those risks.
However, as I also noted, if the rewards on private equity investments were particularly substantial, such high risks might be warranted. However, are they?
In the final quarter of the 20th century, private equity became a significant component of financial activity. Many people believed that private equity was generating high returns by the early years of the twenty-first century. “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” were the reasons given in a 2007 Harvard Business Review article for the ostensibly high returns.
The author might have only mentioned the final point, which is that the other activities were made possible by the “freedom” from regulation. However, the question remains as to how genuine the private equity earnings have been.
The high rates of private equity returns were questioned in 2005 by a study published in the Journal of Finance, which stated that “Average fund returns (net of fees) approximately equal the S&P 500 although substantial heterogeneity across funds exists.” That parenthesis contains the important phrase, “net of fees.” Returns net of fees (the returns to outside investors) were, on average, about similar to the returns of publicly traded companies listed on the S&P 500 since private equity firms demand extremely high fees. Generally speaking, investing in these publicly traded corporations has less risk and costs less than investing in private equity enterprises.
The Harvard Business School has stated in a 2024 working paper that “the recent median PE [private equity] investments do not beat PMEs [public market equivalents] …And, considering the amount of leverage [the PE companies] use, PE performance can actually outperform PMEs on a risk-adjusted basis.
It is unclear whether private equity investments perform better than the alternatives available to creditors and outside investors who fund private equity’s acquisitions of businesses, notwithstanding any objections to these research. Furthermore, getting the pertinent data is extremely difficult. “The lack of available data has been one of the main obstacles [of obtaining a clear understanding of private equity returns, capital flows, and their interrelation],” according to the authors of the Journal of Finance research. As the term implies, private equity is mostly excluded from the obligations for public disclosure.
The method used to evaluate the value of unsold assets is another significant aspect that complicates efforts to quantify profits in private equity. A private equity business requires its investors to hold their funds for a number of years. The company may sell some of the businesses it has acquired throughout that time, and the profits from those transactions are obvious. But as noted by Eileen Applebaum in a 2022 article:
The fund management gives “estimates” of the companies’ values in the years leading up to the fund’s [the specific fund in which the private equity firm controls certain companies] expiration, which is usually ten years. Until the fund reaches the end of its life span and cashs out completely, these estimates may be overly optimistic, inflating the fund’s value and performance. Investors in the fund won’t know how well it did or what it truly earned until after that.
The idea that PE funds do well is based on estimates of the worth of the fund’s unsold inventory.
How much of private equity is composed of these “guesstimates” is unknown from the data that is currently available. Appelbaum does offer data for CalPERS, the massive pension system for California state employees, from 2009 to 2016. According to these figures, CalPERS’s private equity holdings:
For vintage years ranging from 6 to 13 years old, the unsold percentage of the overall value averages 47 percent. As of 2022, 45 percent of the 2009 vintage’s worth is still invested in companies that are mostly estimated by PE fund managers. The percentage of unsold inventory is significantly higher in more recent vintages; the 2016 vintage had 71% unsold inventory. [“Vintage” is the year that CalPERS made its private equity investments.]
According to a May 2024 Financial Times article, private capital businesses have received more money from investors than they have returned to them in gains for six consecutive years, resulting in a $1.56 trillion gap over that time [emphasis in original].”
In a developing industry, it is possible that for a certain amount of time, more money will be collected than paid out. Though not as significant, the difference between inflows and outflows of funds was $0.6 trillion from 2011 to September 2023. In any event, the fact that this disparity has persisted over a number of years indicates that pension funds that invest in private equity firms must heavily depend on the “guesstimates” that the firms provide in order to calculate their returns.
These statistics on private equity firms’ inability to sell off a large number of their investments also highlight the industry’s recent and ongoing challenges. Once more, Appelbaum highlights the problem in a June 2025 article:
Due in large part to the industry’s persistent overvaluation of its portfolio firms since 2022, the private equity sector is underperforming, unable to exit its investments, and unable to provide its institutional investors with a significant return on their investment. The 401(k) and IRA plans appear to be the ideal rescue for the PE millionaires, who are in dire need of money. Additionally, the Trump administration is set up to support them at the expense of regular workers’ retirement accounts, along with other sectors like bitcoin and hedge funds.
That’s exactly what President Donald Trump has done, as I mentioned at the start of part one of this series.
A Concluding Remark
Even more detrimental than the financial machinations of private equity firms and their collaborating public pension fund administrators is the direct harm that private equity businesses cause to society.
The highly unfavorable elements of certain private investment activity have been made clear by the recent scandal involving Steward Health Care hospitals in Massachusetts (which is covered in part one of this series). From 2010 to 2020, the Steward group of hospitals was owned by Cerberus Capital Management, a private equity firm that engaged in practices that seem to have resulted in subpar services and possibly even patient deaths while allegedly collecting enormous fees for Cerberus and its executives. Furthermore, some hospitals that were essential to the health care system in various parts of Massachusetts had to close as a result of Steward’s 2024 bankruptcy filing.
Steward’s experience is not unique. Other medical facilities in the nation that are controlled by private equity have experienced issues. Additionally, other facets of private equity have underperformed and harmed society in other domains. Examples include public housing, jails, and nursing institutions. Additionally, there is the problem of union busting.
Many activities where the socially detrimental behaviors of private equity firms have been severe are connected by common threads. These are frequently activities in which the impacted population (those living in public housing and those incarcerated) has little authority and there is very little competition. Alternatively, people who are impacted are not in a state where they may react to subpar services (such as hospitals and assisted living facilities). However, businesses that were not characterized by these vulnerabilities have also filed for bankruptcy as a result of private equity’s bleeding of enterprises. One example is the experience of Toys “R” Us.
Vulnerable individuals have suffered harm, lost their jobs, or both in each of these incidents. Some have gotten extremely wealthy, while society has suffered. That’s how private equity works.
Arthur MacEwan is professor emeritus of economics at the University of Massachusetts Boston.