# Private Equity’s Quiet Crisis!

An episode of [Patrick Boyle On Finance](https://invisiblenetwork.ai/podcast/1547740313), 19 Oct 2025, 24 min.

Audio: https://traffic.megaphone.fm/APO8436984581.mp3

Private equity has long promised smooth returns, operational excellence, and sophisticated diversification. But behind the pitch decks and performance charts lies a growing crisis. In this video, we explore:🔹 Why private equity firms are struggling to exit investments🔹 The illusion of stability created by stale pricing🔹 The role of leverage in driving returns — and fragility🔹 The push into 401(k)s and what it means for retail investors🔹 The rise of continuation funds, NAV loans, and other liquidity maneuvers🔹 The social and regulatory backlash against PE roll-up strategies🔹 What Bain, Buffett, and Cliff Asness really think about the modelFrom inflated IRRs to collapsing portfolio companies, the cracks are starting to show. Is private equity still a smart bet — or just a sophisticated shell game? Patrick's Books: Statistics For The Trading Floor: https://amzn.to/3eerLA0 Derivatives For The Trading Floor: https://amzn.to/3cjsyPF Corporate Finance: https://amzn.to/3fn3rvC Ways To Support The Channel: Patreon: https://www.patreon.com/PatrickBoyleOnFinance Buy Me a Coffee: https://www.buymeacoffee.com/patrickboyle

## Transcript

[0:00] This August, President Trump signed an executive order
[0:03] allowing private equity firms to tap into America's 4O1K system.
[0:08] The stated goal was to democratize access, to stop
[0:12] babying smaller investors, and to let them play in the same
[0:15] sandbox as pension funds and sovereign wealth fund managers.
[0:20] Nothing says democratization like handing your retirement
[0:23] savings to Apollo. So why are the shares of
[0:27] publicly listed private equity firms underperforming the
[0:30] broader stock market so badly this year?
[0:33] You'd expect a rally instead. The GLPE index is down nearly
[0:38] 10% year to date, and it's even down slightly since the
[0:42] announcement in early August. Apollo and Blue Owl are off more
[0:47] than 20% year to date. KKR, Aries, and TPG are all in
[0:53] double digit decline. Blackstone is down too, with
[0:57] Carlisle and Three I being outliers up more than the S&P.
[1:02] It turns out that letting retail investors into the sandbox
[1:06] doesn't necessarily help if the sandbox is full of broken toys.
[1:11] The Wall Street Journal points out that some of the
[1:14] underperformance might reflect an overhang from the run up in
[1:18] stock prices over the last few years, especially for some of
[1:22] the big firms who rallied ahead of being included in the S&P
[1:26] 500. But there's still concerns
[1:28] hanging over the industry. Private equity firms are
[1:32] struggling to sell prior investments at attractive
[1:35] prices, and without exits, there are no distributions.
[1:39] Without distributions, it's much harder to raise new capital.
[1:43] Private equity is still sitting on trillions in assets, but the
[1:47] flywheel, raise, deploy, exit, distribute and repeat isn't
[1:52] spinning the way it used to. And the push into four O 1 KS
[1:56] looks maybe less like innovation and more like a search for new
[2:00] investors when the existing ones are getting frustrated.
[2:04] The S&P 500 is up around 14% this year if we include
[2:09] dividends. But it hasn't been a broad based
[2:12] rally. The returns have been
[2:13] concentrated in a handful of tech giants, the Magnificent 7
[2:18] minus Tesla, plus Broadcom, which make up more than 1/3 of
[2:22] the index. These firms are growing
[2:25] earnings, throwing off cash and doing it with less leverage than
[2:29] their predecessors. In the.com era, investors have
[2:33] been paying up for profitability and the market has been
[2:36] rewarding them. Private equity doesn't own any
[2:40] of these companies, and it doesn't own anything like them
[2:43] either. PE firms tend to own smaller
[2:46] businesses, often in slower growing sectors and usually with
[2:50] a lot more debt. The typical buyout fund is a
[2:54] leveraged bet on small cap value stocks, the exact corner of the
[2:58] market that's been lagging. It's not unreasonable to expect
[3:02] private equity returns to rise and fall with the broader stock
[3:06] market, adjusted for the additional leverage.
[3:09] But that relationship breaks down when the market is being
[3:12] driven by a narrow set of mega cap tech stocks that private
[3:16] equity funds have no exposure to.
[3:19] The IPO market has been dead for quite a while, and the kinds of
[3:24] companies sitting in private equity portfolios simply aren't
[3:28] what public investors are looking to invest in.
[3:31] Investors are not interested in paying top dollar for slow
[3:35] growth businesses with heavy debt loads, and that's making it
[3:38] much harder for PE firms to exit cleanly.
[3:42] Benchmarking private equity against the S&P 500 has always
[3:47] been a bit of a stretch. The sector invests mostly in
[3:50] U.S. companies, but they're smaller, more cyclical, and more
[3:54] heavily levered. A better comparison might be a
[3:56] basket of small cap value stocks with a few turns of debt layered
[4:01] on top, but even that's generous.
[4:03] Most small cap value ETFs don't charge fees of 2 and 20.
[4:09] Private equity is often described as being an asset
[4:12] class, but it's really just a structure.
[4:14] Most of the capital is deployed through buyout funds, which
[4:18] acquire controlling stakes in private companies using a mix of
[4:22] equity and debt, the debt does most of the heavy lifting.
[4:26] A typical deal might be financed with 60 to 75% leverage, far
[4:31] more than you'd find in a publicly listed company where
[4:35] debt to equity ratios tend to hover around 30%.
[4:38] The idea behind private equity is simple.
[4:42] Borrow heavily, buy a business, improve it or at least manage it
[4:46] somewhat efficiently, and then try to sell it later for more
[4:50] than you paid. The returns are supposed to come
[4:53] from operational improvements, multiple expansion, and most
[4:57] reliably leverage. The people picking the companies
[5:00] to buy often have backgrounds in investment banking or
[5:04] consulting. Whether that qualifies them to
[5:06] run a plumbing supply company, and whether they can run it
[5:10] better than its founder did is a separate question.
[5:13] But hey, if you can model A leveraged buyout in Excel, how
[5:17] hard can toilets be? Private equity funds tend to
[5:21] concentrate their bets in smaller companies, often in
[5:25] mature industries. The reason being that steady, if
[5:28] boring business models are much easier to borrow against.
[5:32] No one wants to lend money to a business with negative or even
[5:36] highly variable cash flows. That gives them exposure to the
[5:40] small cap and value factors tracked by academic finance.
[5:44] Historically, these factors outperformed, but that hasn't
[5:48] happened for quite some time now.
[5:51] PE funds also claim to offer access to the illiquidity
[5:55] premium. The idea is that buying hard to
[5:58] sell assets at a discount and locking up investor capital for
[6:02] years should result in higher long term returns.
[6:06] Whether that premium exists or not is debatable.
[6:09] What's clear is that the fees are high, the leverage is
[6:13] substantial and the exit routes are narrow.
[6:16] Private equity firms like to tell a story.
[6:19] It's it's a story about transformation, of taking
[6:22] sleepy, underperforming companies and turning them into
[6:25] lean, efficient, high growth machines.
[6:28] The protagonists are former investment bankers and
[6:31] consultants who, armed with spreadsheets and strategic
[6:34] vision, unlock hidden value through operational excellence.
[6:39] This is the myth of operational alpha, but the numbers tell a
[6:44] somewhat different story. Most of the returns in private
[6:48] equity come not from operational improvements, but from leverage.
[6:52] A typical buyout is financed with 60 to 75% debt,
[6:56] significantly more than the average for public companies.
[7:00] That leverage amplifies returns when things go well, but it also
[7:04] introduces fragility. But that part of the story is
[7:08] usually left out of the pitch deck.
[7:10] The idea that private equity managers are uniquely skilled at
[7:14] running businesses is hard to square with the resumes of many
[7:18] of the general partners. These are usually people with
[7:21] backgrounds in M&A, not manufacturing.
[7:24] They know how to structure a deal, but next to nothing about
[7:28] how to run a plumbing supply company.
[7:30] The founder that they're replacing, usually with a junior
[7:33] banker, may have spent 30 years building the business in
[7:37] question. The new owners have a five year
[7:39] exit horizon, the ability to borrow huge sums of money, and a
[7:43] model that assumes margin expansion.
[7:46] You might be surprised to hear that margin expansion rarely
[7:50] materializes. Bain's 2025 Global Private
[7:53] Equity Report shows that in the software business that they buy
[7:57] out, margin growth has contributed just 6% to value
[8:01] creation over the last decade. The rest of the return came from
[8:05] revenue growth and multiple expansion in carve outs
[8:09] transactions. Where a private equity firm
[8:11] acquires a non core division or subsidiary from a larger
[8:15] corporation, the story is similar.
[8:17] Pre 2012, sponsors boosted margins by 29%.
[8:22] Since then, that figure has fallen to 2%.
[8:26] Even when operational improvements are real, they're
[8:29] often overstated. As the CFA Institute and others
[8:33] have pointed out, the industry's preferred performance metric
[8:37] since inception, IRR, is highly sensitive to the timing of cash
[8:42] flows and can be gained through subscription lines and bridge
[8:46] loans. It's not a rate of return in any
[8:48] meaningful sense. It's a marketing number or the
[8:52] financial equivalent of Instagram filters.
[8:55] Flattering, but of nothing like reality.
[8:58] Warren Buffett has long criticized the private equity
[9:01] model for this reason. At Berkshire Hathaway's 2019
[9:05] meeting, he noted that investors in PE funds must hold cash on
[9:10] the sidelines ready to be called.
[9:12] That cash earns very little, especially during the 0 interest
[9:16] rate environment of the time, but that doesn't show up in the
[9:20] IRR. The result is a flattering
[9:23] returns number that ignores the real world cost of of capital.
[9:27] None of this is to say that private equity firms never
[9:31] improve the businesses that they buy.
[9:33] Some do. But the industry's aggregate
[9:36] returns, especially in recent years, suggests that operational
[9:39] alpha is more aspiration than reality.
[9:42] The real engine of private equity is just leverage, and in
[9:46] a world of higher interest rates, that engine is starting
[9:49] to sputter. Private equity has long sold
[9:52] itself as a source of stability. In a world of whipsawing public
[9:56] markets, private equity appears to offer smooth, upward, sloping
[10:00] returns. The lines on the performance
[10:02] charts are reassuringly linear. But as Cliff asness of AQ, or
[10:07] famously put it, this isn't stability.
[10:10] It's just stale pricing. The smoothing of returns in
[10:14] private equity is by no means a bug.
[10:16] It's a feature, and for quite some time has been a major
[10:20] selling point. Because private assets aren't
[10:23] marked to market, their prices don't fluctuate with daily
[10:26] headlines or quarterly earnings like publicly listed stocks do.
[10:30] Instead, they're occasionally appraised, often by the fund
[10:34] managers themselves or by third parties hired by the fund
[10:37] managers. This creates the illusion of low
[10:40] volatility. I remember speaking to a private
[10:43] equity fund manager during the credit crunch many years ago who
[10:47] claimed that while every asset in the world had collapsed in
[10:50] value, none of his portfolio companies had even ticked down.
[10:55] The fact that these investments conceal their true volatility is
[10:59] actually appealing to institutional investors bound by
[11:03] solvency rules or performance metrics that penalize draw
[11:07] downs. This illusion, however, comes at
[11:11] a cost. As an article on the CFA
[11:13] Institute website argues, the industry's reliance on, since
[11:17] inception internal rate of return as a performance metric
[11:20] is deeply misleading. IRR is not a rate of return in
[11:25] any meaningful economic sense, in that it's not a return that
[11:29] any private equity investor receives.
[11:31] It's more of a mathematical artifact, highly sensitive to
[11:35] the timing of cash flows and easily manipulated through
[11:39] subscription lines, bridge loans, and delayed capital
[11:42] calls. Consider a common tactic.
[11:45] A fund identifies a deal but delays calling capital from
[11:49] investors. Instead they use a short term
[11:51] loan to finance the acquisition. This shortens the measured
[11:56] holding period and inflates the IRR.
[11:59] Even though the underlying economics haven't changed, the
[12:02] fund looks like it's delivering a 25% return when in reality the
[12:07] investors actual return and accounting for idle cash and
[12:10] fees might be closer to 10%. The investors money has been
[12:14] sitting in bonds waiting for the capital call and instead of
[12:18] taking it the fund borrows money, often at a higher
[12:21] interest rate just so they can show an artificially inflated
[12:25] IRR. Then we have the proliferation
[12:28] of continuation funds. These are vehicles that allow
[12:31] APE Firm to sell an asset from one of its funds to another
[12:35] fund. It also manages and charges fees
[12:38] on the transaction, resets the clock, generates a paper gain in
[12:43] the first fund, creating the appearance of a successful exit.
[12:47] But the ACID hasn't changed hands in any meaningful way.
[12:51] It's a bit like selling your house to yourself at a higher
[12:54] price and declaring a profit. The Bain 2025 report notes that
[12:59] nearly 30% of companies in buyout portfolios have undergone
[13:04] some form of liquidity event, including secondaries, dividend
[13:08] recaps, and NAV loans without a true exit.
[13:11] These financial maneuvers generate cash flow and
[13:14] flattering metrics, but they don't necessarily reflect real
[13:18] value creation. This chart from Bloomberg shows
[13:22] that over the last few years the business is held on to in
[13:25] continuation. Funds are transferred at higher
[13:28] valuations than the ones actually exited from through
[13:32] sales. Investors are starting to notice
[13:35] this. Distributions to paid in capital
[13:38] DPIA, more grounded measure of actual cash returned, has become
[13:43] the metric of choice for many limited partners, and by that
[13:47] measure, the recent performance is underwhelming.
[13:50] Funds launched in 2019 are only just breaking even, and some may
[13:55] never get there. The smoothing of returns may
[13:59] help investors sleep at night, but it also obscures risk,
[14:03] conceals under performance, and makes it harder to distinguish
[14:06] skill from luck. In the end, Volatility
[14:10] laundering, as this technique has been named by Cliff Asness
[14:13] at AQR, is just that, laundering.
[14:16] In the end, it's not true stability.
[14:19] It's opacity dressed up as sophistication.
[14:22] Private equities promise of smooth returns is now colliding
[14:26] with a hard reality. The industry is struggling to
[14:30] convert paper gains into actual cash.
[14:33] The backlog of unsold companies now exceeds $3.6 trillion across
[14:39] nearly 30,000 portfolio firms. Distributions have slowed to a
[14:43] crawl. Bain's report shows the
[14:46] distributions as a percentage of net asset value have fallen to
[14:51] 11%, the lowest rate in over a decade.
[14:55] The IPO market is comatose. Strategic buyers are cautious
[14:59] and sponsor to sponsor deals once a reliable exit route are
[15:03] now viewed with suspicion. Continuation funds, secondaries
[15:07] and NAV loans have stepped in to provide liquidity, but they're
[15:11] more account maneuvers than genuine exits.
[15:15] Liquidity challenges are also distorting valuations.
[15:19] When assets are never actually sold, you have to start
[15:22] wondering about their carrying value.
[15:24] Secondary market discounts, often 15% or more, reveal what
[15:29] investors really think these assets are worth.
[15:32] And that's before accounting for fees, leverage, and the time
[15:36] value of money. The collapse of First Brands,
[15:39] which I covered a few weeks ago and which is becoming a bigger
[15:42] and bigger story, illustrates the fragility of the system.
[15:46] First Brands borrowed heavily, pledged the same collateral
[15:50] multiple times, and relied on opaque invoice financing
[15:53] structures. When it failed, $2.3 billion in
[15:57] assets simply vanished. Creditors are still trying to
[16:01] trace the money. The parallels to Greensill are
[16:04] fairly obvious and troubling. Private credit, which up until
[16:08] now has been marketed as a disciplined alternative to bank
[16:12] lending, now looks more like a blind spot.
[16:14] The bespoke contracts and bilateral relationships that
[16:18] were supposed to offer flexibility instead just
[16:21] concealed problems. Pension funds and insurers who
[16:24] invested now find themselves exposed to risks that they
[16:28] barely understand. The liquidity crunch is also a
[16:32] psychological reckoning. Investors are asking hard
[16:35] questions. What are these assets really
[16:38] worth? When will I get my money back?
[16:40] Why does the fund keep reporting gains when they can't seem to
[16:44] sell anything to outside investors?
[16:47] Until those questions have better answers, the industry's
[16:50] reputation for stability will remain under pressure.
[16:54] The returns may still look smooth on paper, but the path to
[16:58] realizing them is anything bad. In August, as I mentioned
[17:02] earlier, Donald Trump signed an executive order that could
[17:06] reshape the retirement landscape for millions of Americans.
[17:09] The order allows 4O1K plan administrators to include
[17:13] private equity and other alternative assets like
[17:16] cryptocurrencies in defined contribution retirement plans.
[17:21] The move was cheered by Apollo, Black Rock, Carlyle, and the
[17:24] other firms that have spent years lobbying for access to the
[17:28] growing retirement market. The pitch is that these assets
[17:32] offer diversification, potentially higher returns and
[17:35] access to institutional grade investments.
[17:39] But the risks are less widely advertised.
[17:42] Private equity funds come with high fees, long lock ups and
[17:46] limited transparency. They're not priced daily and
[17:50] they're not easy to exit for retail investors.
[17:54] That's a very different proposition than buying an index
[17:57] fund. The lobbying effort behind the
[17:59] order was intense, according to financial disclosures.
[18:03] Apollo and Carlisle pushed hard for regulatory changes.
[18:07] Blackstone work through trade associations Mark Rowan of
[18:11] Apollo argued that the retirement system was
[18:15] overexposed to mega cap tech stocks.
[18:17] We've basically leveraged the retirement system of the country
[18:21] to NVIDIA, he said. The solution, in his view, was
[18:24] to open the gates to private markets.
[18:27] Some firms went further. The Defined Contribution
[18:30] Alternatives Association reportedly argued that four O 1K
[18:35] plans could be sued for not offering access to private
[18:38] equity. Their logic being if PE delivers
[18:42] higher returns then excluding it could be seen as a breach of
[18:46] fiduciary duty. That argument may be legally
[18:49] tenuous, but it reflects either the industries confidence or
[18:54] desperation, and I'll let you be the judge of that.
[18:58] The Bain report note that retail capital is now expected to drive
[19:03] much of the industry's future growth.
[19:05] Semi liquid products, target date funds and model portfolios
[19:10] are being designed to mix public and private assets, and the big
[19:14] private equity firms have all announced partnerships with
[19:17] retirement plan providers. I'm not sure to what extent
[19:21] American investors will fall for this pitch.
[19:24] The one thing most investors have learned over the years is
[19:28] that high fee investments reduce returns.
[19:31] Average expense ratios paid by investors has been falling year
[19:35] after year as investors refuse to pay up for underperformance.
[19:40] The industry's push into four O 1 KS looks less like
[19:44] democratization and more like a search for new capital.
[19:47] When the existing investors are frustrated, I guess the trick is
[19:51] to find new ones. When people from the world of
[19:54] finance criticize private equity, they often focus on fees
[19:58] and performance. But outside of the world of
[20:01] finance, there's plenty of criticism over the industry's
[20:04] impact on society. What happens when ownership is
[20:08] distant? Incentives are misaligned.
[20:10] And the goal is wealth extraction rather than growth
[20:13] and customer focus. The moral critique centers on
[20:17] the social consequences of financial engineering.
[20:21] Congressional investigations into private equity owned dental
[20:24] chains have raised questions about care quality and
[20:28] unnecessary procedures being pushed on patients in the
[20:32] pursuit of profits. Critics argue that the pursuit
[20:35] of EBITDA Rd. can lead to antisocial outcomes from
[20:39] understaffed care homes to hollowed out retailers.
[20:43] Then there's also the antitrust concern around private equity
[20:47] roll up strategies where PE firms by dozens of small
[20:51] businesses in fragmented industries like doctors offices,
[20:55] private schools, restaurants or student housing and then
[20:58] consolidate them into platform companies.
[21:01] The result can be reduced company petition and higher
[21:04] costs for consumers. Private equity thrived in a
[21:08] world of cheap debt. For most of its modern history,
[21:11] the industry operated in a structurally falling interest
[21:15] rate environment. That tailwind is now gone.
[21:19] A huge component of the business model just relies on leverage.
[21:23] When rates were near 0, that was cheap and effective.
[21:27] But as interest rates have gone up over the last two years, the
[21:30] cost of debt soared. Suddenly, the math doesn't work
[21:34] that well. Higher rates mean higher
[21:37] financing costs, lower valuations and fewer exits.
[21:41] Sellers want yesterday's prices, while buyers can't afford them.
[21:46] Many PE backed companies now carry 6 to 8 times EBITDA in
[21:50] debt levels typically associated with junk credit.
[21:54] When interest rates rise, bankruptcy risk rises with them,
[21:58] and the private equity model starts to look a lot more
[22:02] fragile. Private equity firms argue that
[22:05] they can operate in any business environment.
[22:08] But with inflation, tariffs, and policy uncertainty, all of which
[22:12] hit smaller businesses harder than large businesses, it's
[22:16] become increasingly difficult to underwrite new deals with any
[22:20] confidence. Private equity has always
[22:23] pitched itself as a sophisticated alternative to
[22:26] public markets. It claims to offer
[22:28] diversification, excess returns, and stability.
[22:31] But the reality is more complicated than that.
[22:35] The returns are driven by leverage, and the stability may
[22:39] be an illusion, like a toddler's drawing of a roller coaster
[22:42] labeled steady growth. The diversification?
[22:46] Well, that's mostly concentrated bets on small, cyclical
[22:49] businesses that panic at the side of higher interest rates as
[22:54] the industry expands into four O 1 KS and retail products.
[22:59] The pitch is being repackaged, but the fundamentals haven't
[23:02] changed. The fees are high, the exits are
[23:05] uncertain and the returns are shrinking.
[23:08] Retail investors are being sold a feature, but they may instead
[23:12] be buying a bug. The Mirage of sophistication is
[23:15] powerful, but eventually the water seen in the distance has
[23:20] to be real. And for private equity, that
[23:22] means actual exits, actual distributions, and fewer
[23:26] PowerPoint slides about transformational value creation.
[23:30] Until then, the industry may look smooth on paper, but it's
[23:34] starting to sound like a bedtime story told by someone who's
[23:38] already spent your retirement. Thanks again for tuning into the
[23:42] podcast. If you found it interesting, I'd
[23:44] appreciate if you sent a link to a friend to help the podcast
[23:47] grow. Have a great week and talk to
[23:49] you again soon. Bye.

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