Profiting from an expensive game of pass the parcel

Private equity is now firmly part of the investment mainstream, thanks to a record of strong returns. Over the last ten years, European buyout funds have achieved an annual return (as measured by internal rate of return, or IRR) of 15%, according to the European Private Equity and Venture Capital Association. By comparison, the FTSE 250 index – a proxy for the type of mid-sized companies that these funds often invest in – has managed atotal return of just 8.8%.

However, these headline figures disguise a lot of variation. Globally, the top quartile of buyout funds returned over 20% while the bottom quartile barely made a positive return, according to private-equity giant Bain Capital. This shows the need to be selective and the challenge of picking winners. That’s also true of managed funds that invest in listed assets, but there are significant differences between how traditional funds work and how private equity works. Investors should make sure they understand how these returns are achieved, whether they can be sustained