Back in November, I did a blog entry focusing on research showing that average private equity returns have underperformed the benchmark S&P 500 share index by 3 per cent, after fees charged to investors. Excluding fees and carried interest, returns from private equity outperformed the S&P 500 by 3 per cent.

The paper, The Performance of Private Equity Funds by Oliver Gottschalg, an assistant professor of strategy at HEC Paris and Ludovic Phalippou, an assistant professor of finance at the University of Amsterdam Business School, sheds even more light when read in detail.

It indicates that the fees ensure the fund managers capture an excessive rent. The paper also examines the question of why investors allocate money to private equity given its poor historical performance. The researchers suggest that investors might have misvalued it, and put too much weight on a handful of successful investments. More importantly, it is basically impossible for investors to benchmark the past performance of funds with information reported in prospectuses as these documents contain only multiples and internal rates of return GROSS of fees. Take the fees out, and you get a different picture. The problem with internal rate of return (IRR) calculations is that cash proceeds have been reinvested at the IRR over the entire investment period. This overstates the truth.

If you want to read more, you can turn to their piece The Truth About Private Equity Performance in last month's Harvard Business Review.

If you want more detail, you can read it here.