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The Return to Direct Investment in Private Firms: New Evidence on the Private Equity Premium Puzzle


  • I am grateful to an anonymous referee, Morten Bennedsen, David Brophy, Robert Chirinko, David J. Denis, Miguel Ferreira, Jana Fidrmuc, Denis Gromb, Hans Christian Kongsted, Nikolaj Malchow-Møller, Ludovic Phalippou, Thomas Rønde, Carsten Sørensen, Annette Vissing-Jørgensen, Daniel Wolfenzon, and seminar participants at Bocconi University, Cass Business School, Chinese University of Hong Kong, Copenhagen Business School, Durham Business School, Imperial College, Instituto de Empresa, ISCTE Business School, Lund University, Manchester Business School, Tilburg University, University of Copenhagen, the Financial Intermediation Research Society's Conference in Shanghai 2006, the FMA 2006 Meeting in Salt Lake City, the Netspar 2007 Conference in Amsterdam, the Asian FMA 2007 Meeting in Hong Kong, the NTU International Conference on Economics, Finance, and Accounting in Taipei 2008, the Institutional Investors and Asset Management Industry Conference at University of Oregon 2008, and the 2010 EFM Symposium on Entrepreneurial Finance and Venture Capital Markets in Montreal for helpful comments and suggestions. This project has been supported financially by the Centre for Economic and Business Research (CEBR), the Danish Centre for Accounting and Finance (D-CAF), and the Economic Policy Research Network.

  • Contact information: Department of Finance, Hong Kong University of Science and Technology, Clear Water Bay, Hong Kong SAR, China. E-mail:


This paper uses a novel dataset to analyze the return to direct investments in private firms by pension funds. We have two key findings. First, direct investments in private firms have underperformed public equity by 392 basis points per annum under conservative risk adjustments. Second, initial mispricing, due to over-optimism or misperceived risk, and subsequent low capital gains seem to explain the gap in returns to private firms. Overall, these findings complement the finding ofMoskowitz and Vissing-Jørgensen (2002)of low returns on entrepreneurial investments and provide new insight into the existence of what they call the private equity premium puzzle: Even professional investors with well-diversified portfolios like pension funds seem to get a poor risk-return tradeoff from investing directly in private firms.