Kaplan & Schoar (2005)

Citation: Kaplan, S. N., & Schoar, A. (2005). “Private Equity Performance: Returns, Persistence, and Capital Flows.” Journal of Finance.

Kaplan and Schoar’s 2005 paper is the definitive empirical study of private equity fund performance. It addresses three fundamental questions: How do PE funds perform? Does performance persist across funds? How do capital flows respond to performance?

The authors use a comprehensive dataset of PE and VC funds to measure returns net of fees. Their findings have shaped how investors and academics think about the PE industry.

Finding 1: Average PE returns roughly equal public markets.

On average, PE fund returns (net of fees) are approximately equal to S&P 500 returns. This challenges the narrative that PE systematically outperforms. However, there is enormous dispersion—top-quartile funds dramatically outperform, while bottom-quartile funds destroy value. The average masks this heterogeneity.

flowchart LR
  subgraph Return Distribution
    TQ[Top quartile: significant outperformance]
    MQ[Median: roughly market return]
    BQ[Bottom quartile: underperformance]
  end
  TQ --> D[High dispersion]
  MQ --> D
  BQ --> D

Finding 2: Performance persists.

This is the paper’s most important result. GPs who perform well in one fund are significantly more likely to perform well in the next fund. This persistence is much stronger than in mutual funds or hedge funds, where past performance barely predicts future performance.

The implication is striking: in PE, GP skill appears to be real and durable. Unlike public market fund managers who mostly deliver beta, top PE managers seem to have genuine alpha that persists over time. This justifies LP focus on manager selection and explains why access to top funds is so valuable.

flowchart TD
  F1[Fund I performance] -->|Strong positive correlation| F2[Fund II performance]
  F2 -->|Persists| F3[Fund III performance]
  
  subgraph Implication
    MS[Manager selection matters enormously]
    AC[Access to top GPs is valuable]
  end

Finding 3: Capital flows are “sticky” and not fully rational.

In a perfectly rational world, capital would chase returns: more money would flow to high-performing GPs, bidding down their future returns until they equalized. But Kaplan and Schoar find that capital flows are less responsive than they should be. Top GPs raise larger funds, but not so much larger that their returns are competed away. Meanwhile, poor performers continue to raise capital.

This creates a puzzle: why don’t LPs concentrate capital in top-performing GPs? Possible explanations include:

• Capacity constraints (top GPs limit fund size to preserve returns)
• Access constraints (top GPs are oversubscribed; LPs can’t get allocation)
• LP behavioral biases or slow learning

flowchart LR
  HP[High past performance] --> MF[Modestly larger fund]
  MF --> PR[Performance persists despite larger size]
  
  LP2[Low past performance] --> CF[Still raises capital]
  CF --> Q[Why don't LPs learn faster?]

Key implications:

1) Manager selection is the primary driver of PE returns. Unlike public equities, where index funds dominate, PE is a market where picking the right GP matters enormously. The difference between top and bottom quartile is economically massive.

2) Access is a form of alpha. LPs with relationships and track records that give them access to oversubscribed top-tier funds have a structural advantage. This makes LP skill matter too.

3) The 2/20 fee structure is more defensible for top GPs. If skill persists and is scarce, high fees may be a rational price for genuine alpha. For mediocre GPs, the fees are harder to justify.

4) PE markets are not fully efficient. Persistence and sticky capital flows suggest that capital allocation in PE is imperfect. Information frictions, relationship constraints, and behavioral factors all play a role.

PE fund performance is highly dispersed, top GPs persistently outperform, and capital flows are less responsive to performance than efficiency would predict. Manager selection is the central problem in PE investing—and access to the best funds is itself a form of alpha.