After lumbering around the $1trn-$2trn assets under management mark for quite some time, central bank policies in the wake of the global financial crisis were a long-awaited shot in the arm for the private capital industry.

Faced with diminishing returns in traditional 60:40 portfolios, institutional investors started to look for a bit more action. Along came private equity. Between 2008 and 2019, PE assets under management volumes more than tripled to $7trn.

Private capital assets under management by asset class, 2000-19

Did capital allocators simply stumble on the ‘holy grail’ of PE investing? 

Well, they had a little help. AUM league tables and smooth double-digit IRR data for non-listed assets helpfully provided by globetrotting marketing teams of large fund managers were simply too appealing to be ignored by capital allocators tasked with lofty return targets.

Rolling three-year horizon IRRs by asset class

So, is the story of stellar AUM growth and smooth returns just a self-fulfilling prophecy or are we missing something?

Keeping in mind a Buffet phrase from his 1994 Omaha pilgrimage – “Don’t ask the barber whether you need a haircut” – let’s look at some of the alternative arguments brought forward by the academic community.

Let’s start with a simple observation: An IRR does not measure risk. It measures the discount factor for a series of cash flows to arrive at a net present value of zero.