The economic conditions that lifted the public securities markets in 1995 - low inflation, falling interest rates and an appetite for initial public offerings and technology stocks - also are giving long-term investors attractive returns on private equity investments.
The booming IPO market, the intense interest in the technology sector and the vibrant public market mean many companies going public through IPOs are bringing up to 10 times the initial private investment.
Buy-out, mezzanine and other private equity funds formed between 1981 and 1994 returned 21% for the year ended June 30 and averaged nearly 20% for the two years, according to Venture Economics Investor Services, a Boston research and information firm specializing in private equity and venture capital markets.
Institutional investors with holdings in late-stage private equity partnerships, those formed between 1980 and 1990, have experienced a median annual internal rate of return of 12.5% through June; many have seen returns in excess of 20%, according to Gary Robertson, investment consultant at Callan Associates Inc., San Francisco.
By contrast, the Standard & Poor's 500 Stock Index returned an average of 12.09% for the five years ended June 30 and 14.66% for the 10-year period.
Most private equity partnerships aim for returns of 15% to 20% annually. Mr. Robertson said most pension fund investors that invest in a diversified portfolio of "well-constructed" private equity partnerships usually outperform the median returns.
Record new commitments have been made to private equity by institutional investors. According to Callan, more than $21 billion has been committed this year as of Oct. 30, vs. $21.8 billion in all of 1994 and $12.2 billion in 1993.
Pension funds represent about half of the new money flowing into private equity partnerships, Mr. Robertson said.
"The public markets have been strong, and it is likely the rates of return in the private equity market have been superior this year. Partnerships started five to seven years ago have already been through an investment and development cycle, and companies are poised to take advantage of the move in small-cap and technology markets today," he said.
Private equity partnerships typically invest in small, emerging companies not traded in the public markets. Technology companies are particularly attractive, as are buy-out prospects or divisions of larger companies sold off to private investors.
"From an efficient frontier perspective, the pattern of returns (in private equity) is different from the public markets," said Tom Pipich, investment consultant with Buck Consultants, Pittsburgh. "If the S&P is up 40% for example, private equity investments may do well too. But you may get 20% from private equity investments even if the stock market is flat.
The companies are developed and grow and are either sold at a profit in a public offering or retained and continue to generate income for investors.
Private equity partnerships take several forms, including traditional venture capital, buy-out funds, mezzanine debt financing funds and traditional private equity investments in non-publicly traded firms. The partnership horizon extends for 10 to 12 years, and investors typically do not start receiving returns until three to five years into the partnership, giving private equity a reputation for having liquidity problems.
Mr. Robertson said median returns for private equity partnerships "will have increased substantially" by the end of 1995 because of the activity in the small-cap, IPO and technology markets.
William F. Quinn, president of AMR Investments, Fort Worth, Texas, which oversees nearly $8 billion in employee benefit assets of American Airlines, said the long-term nature of American's private equity portfolio is responsible for higher return expectations.
"Our goal is to see a 20%-plus return" for private equity, said Mr. Quinn. American started investing in private equity partnerships in 1988 and calculating returns during the first few years is not exact, he said. "But from what we can tell, we are on track to do that (20% plus) or even a little better," he said.
American has committed about $240 million in defined benefit assets to private equity partnerships since 1988. Mr. Quinn said many institutional investors favor private equity because prices are usually lower than for publicly traded ones.
The $58 billion California State Teachers' Retirement System, Sacramento, has committed about $1.8 billion to private equity through various venture, special situation and mezzanine funding partnerships.
Solomon Owayda, senior investment officer, said the fund - in the eighth year of its private equity program - averaged returns in excess of 15% annually for the past seven years. He said private equity returns have exceeded returns from the public equity markets.
Buck's Mr. Pipich said most private equity investors tend to be university endowments, which have longer term investment horizons, and public pension funds.
Funds with meaningful commitments to private equity include endowment funds at Stanford University, the University of Houston, Harvard University, Yale University, the University of Michigan and the University of Texas, as well as large public pension funds such as the California Teachers, Minnesota State Board of Investments and the Massachusetts State Teachers' & Employees Retirement System.