Money has been pouring into alternative investments, and that has prompted concerns that too much money might be chasing too few good ideas —usually a recipe for lower returns.
A recent PitchBook Data Inc. study found more than $3 trillion flowed into private equity and venture capital funds worldwide between 2009 and 2018, with private equity funds raising $2.6 trillion of the total. Private equity raised $500 billion in 2018 alone, the study showed.
This flood of money could affect long-term returns. In fact, there is evidence it might already be doing so.
Research by economists Robert S. Harris, Tim Jenkinson and Steven N. Kaplan, published in the Journal of Investment Management in 2015, found average buyout fund returns for all vintage years but one before 2006 have exceeded those from public markets by about 3% to 4% annually. Post-2005 vintage year returns, on the other hand, have been roughly equal to those of public markets.
If such market-equaling returns continue, there will be little reason for investors to continue to commit large sums to private equity. The benefits of diversification would not be enough to compensate for the illiquidity of the investments.
Because of a surge of money into private equity funds, "overall, these results suggest that an influx of capital into buyout funds is associated with lower subsequent performance," the economists wrote.
In other words, as huge amounts of money continue to flow into private equity funds the returns are likely to drop. It's possible that private equity returns on a risk-adjusted basis could be lower than publicly traded stocks.
That is something for executives at pension funds, endowments and foundations to consider as they contemplate an appropriate allocation to private equity.