Why are private markets outperforming public markets?

Liquidity premium

Fake. Private equity returns are largely marketing .

Once you factor out added leverage and small cap premium the returns are far less impressive.

If you used similar leverage on sp 500 futures the futures would dominate.

I currently work in private markets. It does boil down to liquidity premium at some level; but private markets provide a lot of room for innovative return unavailable in public markets if done correctly.

Public markets don't serve all companies well - companies may find themselves capital-constrained without adequate time to access and syndicate from public markets. Banks and other asset managers have risk, size, and liquidity constraints that prevent them investing or lending to certain companies; and they make money perfectly well in public markets.

Thus, companies below a certain size or in a time-crunch may find the debt or equity they wish to issue is too expensive in the public space. They go to private markets (PE, family offices, sponsors, and boutiques) who recognize the potential opportunity in the prospective investment; and are generally offered a higher return for the lack of liquidity and other potentially unattractive aspects (size, overloaded debt ratio, etc.)

However, the true value in private markets is the ability to tailor your return structure to suit the needs of both the investor and issuer. Company needs a ramp up for three months after Litigation expense? No problem - interest can be accrued as a PIK for that period only. Company will generate increasing cash-flow at an exponential rate? We can schedule the amortization schedule as an exponential rate as well. Coupon is too low for a given risk profile? We can extract surplus return via private leverage (PE firm or other stands in as creditor), ask for extra warrants, set OID rate, etc. Factors that are exotic to a normal credit or equity investor can be regularly structured in private markets for attractive return.

Blackstone's Tac Opps is a good example of opportunistic private-market investing; although I believe their general mandate is public/private.

That being said; bad private market investments are near-impossible to sell off, so it does eventually come down to the question of liquidity. Like everything else, no free lunch.

.

I don't doubt that the private market does well, especially the big boys, but all these returns stated are not regulated and you would need them to be risk adjusted to compare them to the S&P 500 for example. Also, private equity opportunities aren't available to the general public like the public markets are, you need to be a qualified investor (>1M wealth). I am talking about direct investment here, not the PE ETFs that feast on your annual fees.