Chapter 8: Where Private Equity Is Headed - The Conclusion
This is the final chapter. Demaria wraps up the whole book by looking forward. Where is private equity going? What are the big risks ahead? And could the industry actually destroy itself by being too successful? Let’s go through it.
Big Players Keep Getting Bigger
After the 2007-2009 crisis, some consulting firms predicted that 20-40% of fund managers would disappear within a few years. That did not happen. About 90 PE fund managers vanished in 2009, and by 2011 only 183 were winding down while 130 new ones were showing up. There were still over 4,100 active managers. No mass extinction.
Why? Because management fees are sticky. Even a struggling fund manager collects fees for years before the money runs out. Some firms died, sure. Candover went into liquidation in 2010 after 30 years. Duke Street switched to deal-by-deal. But the predicted shakeout was wildly overblown.
What did happen is a slow concentration. Three things are pushing bigger players ahead. First, regulations cost money. Compliance is expensive, and large firms spread that cost across many funds. That creates a natural barrier against newcomers. Second, brand recognition matters. Big names attract investors who feel safer going with someone they have heard of, even if past performance is not a reliable predictor of future returns. Third, the founders from the 1970s and 1980s are retiring. Instead of passing the business to the next generation, many are just selling the whole operation.
Better Ways to Measure Risk
Risk in private markets cannot be reduced to a single number. Demaria identifies at least five different risk measures. There is strategy-level risk (how a whole category of funds performs across vintage years), fund-level risk (how often funds in a given strategy lose or make money), active fund risk (comparing ongoing fund performance to fully realized ones), fund selection risk (how good the investor is at picking managers), and liquidity risk (how long until you get your money back).
These tools are new and still being refined. The tricky part is that private equity risk is both internal and external. External because exits depend on public markets, interest rates, and the overall economy. If listed markets crash, PE exits suffer too. Internal because personal chemistry matters, past performance rarely predicts future results, and markets evolve fast enough to make a five-year-old strategy obsolete.
The real due diligence is not about crunching numbers. It is about understanding the fund manager as a person. Talk to former CEOs of their portfolio companies. Talk to former employees. Get honest feedback. That is worth more than any spreadsheet.
Long-Term Thinking Is the Only Thing That Matters
An entire generation of PE fund managers is about to retire. The big question: did they build teams that can carry on? Did they train successors properly?
Demaria expects returns to trend downward over time. More capital flowing into private markets means more competition for deals, which means higher prices, which means lower returns. This has already happened in US venture capital and large US buyouts. The sector is maturing. Fund investors know this and are getting pickier about which managers they back. At the same time, fees stay stubbornly stable. That squeeze between lower returns and fixed costs is a real problem.
Fair Market Value Changes Everything (And Not for the Better)
This is one of Demaria’s strongest opinions in the chapter. The FAS 157 accounting rules require PE fund managers to value their portfolio companies as if they could be sold tomorrow, using comparable public company prices. Demaria thinks this is, in his words, “complete nonsense.”
The logic: private equity is about holding companies for years, improving them, then selling. Forcing quarterly mark-to-market valuations imported from public markets introduces artificial volatility. Volatility equals risk in accounting terms. Risk requires capital reserves. So these rules effectively made it more expensive to invest in small and medium businesses. The very thing PE is supposed to help.
The irony is rich. Large buyout managers like Blackstone supported fair value rules in 2003 when markets were booming. After 2008, they complained about the impact. Meanwhile, funds of funds, which statistically reduce risk through diversification, were “deafeningly silent” in the debate about whether these rules made sense. Demaria clearly questions their usefulness when they cannot even defend their own case.
Private Markets Keep Growing
Despite all these issues, money keeps flowing in. Preqin estimated PE assets under management at $3.4 trillion in 2018, projected to reach $4.9 trillion by 2023. Institutional investors allocated about 14% to private markets and that was expected to grow to 20% over the next decade. More capital is coming from Asia-Pacific, sovereign wealth funds, and family offices.
But there is a natural speed limit. Economies can only absorb so much capital. Pour in too much too fast and valuations inflate, returns drop, and you get bubbles. The dot-com era (1999-2001) and the LBO boom (2007-2010) showed exactly that pattern. Slow and steady deployment is the only way to keep returns healthy.
Cultural and behavioral factors also play a role. Fund investors are not perfectly rational. They follow fashion, have home bias, are overconfident, and react to noise. The quality of the whole sector depends on how well investment teams resist these tendencies.
PE as a Victim of Its Own Success
Here is the paradox. In 2017, more capital was raised privately in the US ($2.4 trillion) than on public markets ($2.1 trillion). Private markets overtook public financing back in 2011. PE funds are involved in a quarter to a third of all M&A deals. The industry is massive.
If PE becomes too big and too common, it risks becoming a commodity. Secondary buyouts are already normal, representing 30-40% of all LBO exits. The French company Frans Bonhomme went through four successive LBOs between 1993 and 2005, with each fund adding value and passing it along. That is the system working well.
But commoditization brings problems. More capital chasing the same deals means higher entry prices and lower returns. Applying PE techniques to riskier or more regulated companies could backfire. And the Toys ‘R Us disaster, where PE-backed management took a profitable company into bankruptcy, showed what happens when the model is applied carelessly.
The fee debate continues. Management fees above EUR 250 million in fund size are usually more than enough to cover costs. Yet managers resist lowering them. Some investors have gotten creative by buying stakes in the fund management company itself, effectively getting a portion of fees back through the side door. Clever, but not a real fix.
Better Knowledge, New Options, New Dangers
As the industry matures, investors understand more about how it works. They know the J-curve profile. They know that funds rarely deploy 100% of committed capital. Some investors over-commit (up to 130-140% of planned allocation), counting on that gap. This backfired during the crisis when distributions stopped but capital calls kept coming.
Co-investing alongside fund managers has exploded. Amounts jumped from $40-50 billion in 2012-2013 to $100-110 billion by 2016-2017. The appeal is obvious: better returns, lower fees, more control. But co-investing requires different skills than fund investing. Due diligence is compressed to weeks instead of months. There is adverse selection risk, because fund managers tend to offer co-investment on deals they cannot fully finance or want to spread the risk on.
And then there is regulation. Basel III and the Volcker rule pushed banks away from PE. Solvency II did the same for European insurance companies. These rules made sense for giant LBO firms, but they hit small fund managers hard. Compliance costs create barriers to entry. Carried interest tax treatment is under constant political pressure.
Demaria makes an interesting suggestion near the end. Maybe the industry should split. Let the mega buyout shops become regulated financial institutions (basically new versions of investment banks). Let the rest of the industry, the venture capital and growth capital and mid-market players, stay in a lighter regulatory environment focused on entrepreneurship and value creation.
That split might actually save private equity from itself.
Previous: Chapter 7: Ethics and Responsibilities