EDHEC: Are private equities riskier than stocks?
By Abhishek Gupta, Associate Director at Scientific Infra & Private Assets, and Srinivasan Selvam, Senior Researcher in Finance – Solutions at Scientific Infra & Private Assets
Investing in private equity funds implies not only significant exposure to private equities market risk, but also highly variable levels of risk depending on the exposure to each segment and risk factor created by fund managers through their investment selection process. These risk exposures are priced in a market for private equities as a function of supply and demand for different types of firms.
In a recent report[1], we find that private equities, as represented by the private2000® index, have a ten-year volatility of returns and an extreme risk profile that is commensurate with that of listed equities, but that the maximum drawdown of public equities is consistently higher than that of private equities.
Private equities market risk
While they mostly invest in private assets via funds, investors select and mandate private equity managers primarily to gain exposure to private equities market risk, which is the sum of the risks found in the market for investing in private companies. Of course, investors in private funds also face other risks, such as liquidity and cash flow risks, by virtue of investing through a partnership structure. They do so because they often need fund managers’ skill to access private markets, and because they expect the delegation of investment selection and management to a specialist to be value-enhancing and to maximise net returns.
But despite the key role of fund managers in this process, gaining exposure to private market risk must remain the main motivation of any investor in a private equity fund. Indeed, such investments are made in a market of willing buyers and sellers, and their value is therefore subject to the forces of supply and demand. Changes in investors’ views and preferences for one or other sector, technology or business model leads to rising and falling asset prices, albeit less rapidly than in the market for public equities.
In the end, market risk (and returns) will determine a large part of the outcome. One does not imagine an LP mandating a manager, however highly skilled, to invest in a disappearing or terminally declining market. Private equities market risk is central to any private market investment strategy.
The privateMetrics indices that are produced by Scientific Infra & Private Assets (SIPA) have been designed to measure the risk-adjusted performance of the private equities market before fund managers bring their skills to bear and make specific investment choices, add fund-level risks, or mitigate idiosyncratic risk. These market indices represent private equities as an asset class and are therefore the most relevant and logical starting point to understand and undertake private asset investing.
Key insights
In this report, we find that:
- Private and public equities exhibit commensurate levels of risk.
- Private equities have experienced less downside over the past decade, but this corresponds to an unprecedented period of demand growth and subsequent increases in market prices which may not be repeated.
- Private equities market risk has been decreasing slightly (but mostly on the upside) over the past decade, while public equities market risk has increased.
- Private equities market indices produced with the privateMetrics asset pricing model capture the variance of observable private equities transactions.
- The risk of investing in private equities at the micro-economic level can be traced back to systematic factors such as size or profits or revenue growth. This, in turn, justifies the importance of measuring private equities market risk within a systematic risk framework.
- Investing in private equity funds implies significant exposure to private equities market risk, but also highly variable levels of risk depending on the exposure to each segment and risk factor created by fund managers through their investment selection process.
[1] The full version of the research, “Are Private Equities Riskier Than Stocks?” Scientific Infra & Private Assets publication, January 2025, is available here.