Private Equity Fund

A private equity fund raises committed capital from institutions, then spends ~five years buying entire companies — usually with substantial borrowed money ("leveraged buyouts") — and another five improving, growing or restructuring them before selling to strategic buyers, other funds, or the stock market.

Investors ("limited partners") don't hand over cash upfront: they commit it, and the fund calls it deal by deal. Money comes back years later as companies are sold. In between, your investment is a paper valuation you cannot sell easily — illiquidity is the defining trade-off.

The pitch: control lets PE fix what public shareholders can't, leverage amplifies equity returns, and patient capital escapes quarterly-earnings myopia. The critique: much of the historical return came from cheap debt, rising valuation multiples and fee-flattered accounting rather than operational magic.

Fund mechanics

• Structure: 10-year closed-end partnership; GP (the firm) manages, LPs invest. Commitment → investment period (~5y) → harvest.
• Economics: ~1.5–2% management fee on committed capital, ~20% carried interest above an 8% preferred return, with GP catch-up. Deal, monitoring and transaction fees layer on top.
• The J-curve: early years show negative returns (fees, immature marks); distributions arrive in years 4–10.

The LBO template

Buy at 10x EBITDA with 50–60% debt; grow EBITDA, pay down debt, hope for multiple expansion; exit at year five. Returns decompose into exactly those three levers — leverage, operations, multiple — and honest attribution asks how much came from each.

Liquidity workarounds

Secondaries (selling LP stakes, usually at discounts to NAV), continuation vehicles (GPs selling companies to themselves — now a quarter of exits, with obvious conflicts), and NAV loans (borrowing against portfolios) — a growing engineering layer that regulators watch closely.

Valuation and performance measurement

Portfolio companies are marked quarterly by appraisal (comparables, DCF) — smoothed, lagged, and discretion-laden. Performance metrics each fail differently: IRR is gamed by subscription-line timing; MOIC ignores duration; the cleanest is PME (public market equivalent) — discounting the fund's actual cash flows at a public index's returns:

Academic consensus: median buyout funds roughly matched public equity net of fees in recent vintages; top-quartile persistence exists but has weakened. Selection and access are the entire game.

Risk you can't see

Reported volatility (~10%) is an artifact of appraisal smoothing; de-smoothed betas run 1.2–1.5 with public equity plus leverage. The illiquidity premium is contested — some estimates put it near zero after unsmoothing; the "volatility laundering" debate (Cliff Asness's term) is precisely about allocators paying for hidden beta.

Systemic footprint

PE-owned companies now employ ~12M Americans; leveraged-loan and private-credit markets exist substantially to finance PE. Rising rates post-2022 stress the model: interest coverage in portfolios fell sharply, exits slowed, and the industry pivoted to continuation funds and dividend recaps to return capital — the current cycle's live experiment.