Private Equity at a Crossroads: A Conversation with Ludovic Phalippou

Ludovic Phalippou, PhD, Professor of Financial Economics at Oxford University, has become one of the most closely followed and debated voices in private equity. His articles on Enterprising Investor were among the most read in 2024, and I was pleased to sit down with him for a wide-ranging conversation. Known for his sharp analysis and independent perspective, Phalippou has long challenged the industry’s dominant narratives, and he does so during our conversation with his usual clarity and candor.

In our discussion, which will air on May 21 on YouTube, Phalippou revisits several of the themes that have defined his research: performance reporting, governance, incentives, and transparency. But we also explored how the current macro environment and the changing investor base are placing new pressures on an already complex system. The result is a thought-provoking look at where private equity stands today and where it may be heading.

Impact of Rising Interest Rates

Phalippou begins by discussing how the current macroeconomic environment, particularly rising interest rates, is exerting pressure on private equity firms. He explains that higher borrowing costs directly affect the leveraged buyout model that has traditionally underpinned private equity returns. As debt becomes more expensive, deals need to generate higher operational improvements or revenue growth to offset this financial burden. Phalippou emphasizes that many PE firms are now resorting to financial engineering or restructuring debt to avoid public bankruptcies. However, he warns that these tactics may not be sustainable if the high-interest environment persists.

Transparency and Governance in Private Equity

One of Phalippou’s central critiques is the lack of transparency in private equity, which he likens to the mutual fund industry of the early 20th century before reforms were implemented. He calls for standardized reporting and stricter governance to protect investors, particularly as private equity becomes more accessible to retail markets. He highlights issues with traditional metrics like internal rate of return (IRR) and delves into the way in which IRR can be manipulated to present an overly optimistic picture of performance.

Performance Myths and Misconceptions

Phalippou challenges the widely held belief that private equity consistently outperforms public markets. He argues that the metrics used to support this claim often fail to account for survivorship bias or the lack of appropriate benchmarks. According to Phalippou, the perception of superior returns is frequently based on selective reporting and marketing rather than reality.

Alignment of Interests

Another key theme in the interview is the alignment — or misalignment — of interests between private equity fund managers, executives, and investors. Phalippou highlights the importance of understanding who benefits most from PE structures. He notes that while fund managers often claim their interests are aligned with those of investors, the reality is more complex, and he shares examples.

Environmental, Social, and Governance (ESG) Practices

When asked about ESG initiatives in private equity, Phalippou offers a nuanced view. While he acknowledges that ESG compliance is increasingly important, he suggests that many firms approach ESG more as a marketing tool or regulatory requirement rather than as a genuine driver of value creation. He makes observations about some ESG initiatives and discusses ESG reporting in private equity.

Private Equity in Sports Franchises

Phalippou touches on the growing involvement of private equity in owning sports franchises. He characterizes this trend as a blend of professionalization and vanity projects. While private equity firms bring operational discipline and financial expertise to sports management, there is also an element of prestige and personal ambition that drives these investments.

The Role of Academia

Reflecting on his role as an academic, Phalippou discusses his efforts to demystify private equity for his students and foster critical thinking. He aims to go beyond the surface-level jargon of the industry and equip students with the tools to ask deeper, more critical questions about the data and assumptions behind private equity practices.

Challenges Facing the Private Equity Industry

Phalippou outlines several challenges that private equity firms are likely to face in the coming years. These include:

1. Increased Scrutiny: As private equity becomes more accessible to retail investors, it will face heightened scrutiny from regulators and the public.
2. Saturation of the Market: The influx of capital into the private equity space has led to higher valuations and reduced opportunities for outsized returns.
3. Technological Disruption: The rise of AI and data analytics is transforming the way due diligence and operational improvements are conducted, potentially disrupting traditional private equity practices.

Future of the Industry

Phalippou concludes with a discussion of where private equity might be headed. He brings data and deep research to bear on issues that many in the industry still treat as settled. His perspectives on current practices and future direction are clear, direct, and thought-provoking — whether or not you agree with every conclusion. This discussion is a valuable opportunity to revisit long-held assumptions and consider how the private equity landscape may evolve in the years ahead.