Is it truly possible to replicate private equity performance in the public markets? A new study from the University of Pennsylvania’s Wharton School argues that it isn’t.

Equity investors are increasingly seeking to deliver private-equity-like returns in the public markets, but it may not be possible to replicate some of the drivers of leveraged buyout performance outside of private equity, according to the study, by PhD candidate Alexander Belyakov. He concluded that a “large portion” of the excess returns delivered by private equity firms can be explained by the differences in behavior between companies with and without private equity owners.


In particular, Belyakov argued that private equity backing relaxes some of the constraints on portfolio company operations, because they have owners that can “rescue” them from financial distress. “Private equity firms act as deep-pocket investors: when the internal cash flow of their portfolio companies is insufficient to fully finance investments and/or make required debt payments, the private equity owner steps in and provides additional capital,” Belyakov wrote in the paper.


For example, he found that private-equity-backed companies are willing to take on more leverage and make large investments more frequently. These companies end up growing faster, which Belyakov attributes to better access to external financing. “Empirically, numbers unequivocally support the conclusion that companies with private equity ownership outperform companies without private equity ownership,” he wrote.


The study comes as quantitative investors and other asset managers seek to deliver private-equity-like returns through indexes and stock funds. One such firm is Dan Rasmussen’s Verdad Advisers, which invests in small, cheap, and leveraged stocks.

While Rasmussen cautioned against drawing serious conclusions from the Wharton paper, given its relatively small sample size and manually collected data, he agreed with some of the findings, including the role that add-on acquisitions play in private equity returns and Belyakov’s conclusion that private-equity-owned companies do not appear to deleverage over the course of buyouts.

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The paper’s model for how cash injections in times of distress result in different incentives for private-equity-owned companies is also “very interesting and worth further investigation,” Rasmussen said. “Right now, it's a mathematical hypothesis, and it’s unclear how often this happens or how important it is to outcomes. But this question would have interesting conclusions both for private equity and for private credit.”


Belyakov based his conclusions on a quantitative model he built to analyze how expectations about financial distress can explain the differences between companies with and without private equity ownership. The paper also analyzed empirical data that Belyakov and his team manually collected on 407 buyouts in the U.K., where private companies are required to file annual reports.

Based on the model and empirical analysis, Belyakov concluded that the “abnormal returns [of] PE firms cannot be replicated by other investors.”