Benchmark choices might blur view of performance

Private equity investors may be getting an inflated view of performance due to their choice of benchmarks, said Ludovic Phalippou, professor of financial economics at Said Business School, University of Oxford.

Mr. Phalippou said institutional investors have been measuring their portfolios against the wrong benchmarks that artificially show private equity's outperformance against stocks.

Until about five years ago, investors measured their private equity portfolios against the S&P 500 and other value-weighted benchmarks, seeking a premium over that index, he said.

"Pre-2008, the 10% largest stocks in the U.S. had their worst decade ever, while the other type of stocks did about the same as in any other decade," Mr. Phalippou said. "Private equity invests in midcap and had returns similar to midcap stocks pre-2008, but, of course, a lot higher than S&P returns since midcap outperformed the S&P 500 and some badly constructed midcap indices, which were then popular as benchmarks."

Since 2008, the S&P 500 has slightly outperformed midcap and small-cap stocks.

"To me, this does not look like performance going down but like silly benchmarking," he said.

Lately, many investors have moved away from a premium over the S&P 500, switching their benchmarks to a premium over the MSCI World Equity index instead. The MSCI World is not much of an improvement, Mr. Phalippou said.

"MSCI World is one of the worst-performing stock indices out there, mainly due to a strong dollar against emerging market currencies," he said. "So all (investor) presentations now still show PE well ahead of public equity."

It's hard to justify investing in private equity unless you invest in above-average funds, he said.