Key Takeaways
- • Performance persistence has collapsed: GMO research finds that prior strong performance by private equity managers no longer reliably predicts future outperformance, particularly for funds less than 10–15 years old, undermining a core justification for PE allocations.
- • Wide performance dispersion persists but is no longer predictable: While significant variation exists among PE funds of the same vintage, institutional investors can no longer systematically identify which managers will outperform, making manager selection increasingly difficult.
- • Institutional investors underperforming PE composites: Some large institutional investors accustomed to beating broader private equity benchmarks have failed to do so consistently in recent years, contrary to historical norms.
- • High fees no longer justified by expected outperformance: GMO recommends raising the bar for PE manager hiring and suggests that deploying capital in public markets at lower cost may be superior to paying high PE fees without confidence in manager quality.
- • PE portfolio concentration risk escalating: Beyond performance issues, GMO identifies growing concentration in private equity portfolios around a small set of correlated risks, compounding challenges for PE-heavy allocators.
Summary
Ben Inker, co-head of GMO's Asset Allocation team, has raised significant questions about the fundamental case for private equity allocations in a detailed letter to institutional investment committees. Inker's analysis, grounded in decades of buyout data, challenges the core narrative that has long supported substantial PE commitments among sophisticated investors.
The critical finding centers on a structural shift in private equity manager performance: the historical relationship between prior outperformance and future success has effectively disappeared. According to GMO's research, while wide performance dispersion continues to exist among private equity funds raised in the same vintage year, the persistence of outperformance from one fund to the next has largely vanished, particularly when evaluating interim performance from funds less than 10–15 years old. This breakdown in predictability directly undermines the manager selection process that institutional investors have traditionally relied upon to justify PE allocations.
Institutional investors who had grown accustomed to outperforming broader PE composites are discovering they have not achieved consistent outperformance in recent years. Rather than attributing this underperformance to broader market shifts, many investment committees have blamed specific manager selection decisions or biases. However, GMO's analysis suggests a more systemic culprit: the collapse of manager performance persistence itself, which may represent a "new normal" rather than a temporary anomaly. If this lack of persistence persists, meaningful outperformance relative to PE composites will become extremely difficult to achieve going forward.
Inker's recommendations are direct: institutional investment committees should substantially raise the bar for hiring private equity managers and consider alternative deployment strategies. GMO argues that allocating capital to relatively cheap public market opportunities may deliver superior risk-adjusted returns compared to paying the high fees demanded by private equity managers absent compelling confidence in their capabilities. Beyond performance concerns, GMO also identifies growing concentration risk within PE portfolios, where returns increasingly depend on a narrowing set of correlated risk factors, further complicating the risk-return calculus for PE-heavy allocators.
The critical finding centers on a structural shift in private equity manager performance: the historical relationship between prior outperformance and future success has effectively disappeared. According to GMO's research, while wide performance dispersion continues to exist among private equity funds raised in the same vintage year, the persistence of outperformance from one fund to the next has largely vanished, particularly when evaluating interim performance from funds less than 10–15 years old. This breakdown in predictability directly undermines the manager selection process that institutional investors have traditionally relied upon to justify PE allocations.
Institutional investors who had grown accustomed to outperforming broader PE composites are discovering they have not achieved consistent outperformance in recent years. Rather than attributing this underperformance to broader market shifts, many investment committees have blamed specific manager selection decisions or biases. However, GMO's analysis suggests a more systemic culprit: the collapse of manager performance persistence itself, which may represent a "new normal" rather than a temporary anomaly. If this lack of persistence persists, meaningful outperformance relative to PE composites will become extremely difficult to achieve going forward.
Inker's recommendations are direct: institutional investment committees should substantially raise the bar for hiring private equity managers and consider alternative deployment strategies. GMO argues that allocating capital to relatively cheap public market opportunities may deliver superior risk-adjusted returns compared to paying the high fees demanded by private equity managers absent compelling confidence in their capabilities. Beyond performance concerns, GMO also identifies growing concentration risk within PE portfolios, where returns increasingly depend on a narrowing set of correlated risk factors, further complicating the risk-return calculus for PE-heavy allocators.
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