One academic argues in favour of public equity’s transparency in a volatile economy, while another looks to private equity’s future gains.
Yuanshun Li, associate professor, interim chair, finance, Toronto Metropolitan University
In today’s climate of persistent inflation, uneven global growth and a recent pivot towards monetary easing, investors are rightly re-evaluating risk.
While private equity continues to attract capital, I argue that public equity currently presents the safer, more transparent harbour for institutional investors.
The core advantages of public equity are its non-negotiable liquidity and transparent price discovery. While daily volatility can be unsettling, it’s at least a known quantity. Many observers point to the strong market rebound since 2022 as a sign that valuations are stretched and thus high risk. I would argue the opposite: given the emerging trend of interest rate cuts in both the U.S. and Canada, further upside in public equity prices isn’t merely possible, but probable. Critically, if an investment thesis sours, an investor can react immediately.
However, this environment won’t lift all boats equally. Over the next three to five years, broad market indices (like the S&P 500 or TSX composite) will likely underperform specific, high-growth sectors. For public equity investors, this implies that the path to outperformance and to managing risk may lie in a less diversified, more concentrated portfolio.
Private equity, by contrast, faces profound and opaque risks since it’s defined by information asymmetry. This highlights a key distinction: public equity is safer for investors that rely on public information.
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This isn’t an argument for eliminating private equity. However, in an environment where flexibility and speed carry a premium, the risks we can see and price in transparent public markets are far preferable to the risks we can’t see in opaque private ones.
Ludovic Phalippou, professor, financial economics, Said Business School, Oxford University
Current private equity portfolios face materially higher near-term risk than public equities.
Many buyouts completed before the recent repricing wave were loaded with debt that wasn’t adequately hedged against rising rates or slowing cash flows. That combination produces a fragile capital structure: heavy leverage relative to operating cash flows, limited liquidity buffers and elevated refinancing risk.
When earnings underperform, lenders and sponsors often resort to extend and pretend, rolling or rescheduling debt rather than recognizing losses. That practice postpones pain and concentrates tail risk, increasing the chance of covenant breaches, distressed sales or bankruptcy once creditors lose patience.
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That said, committing new capital to private equity today isn’t the same as owning legacy exposures. New commitments will be drawn down over 12 to 24 months and largely deployed at current, lower entry prices with contemporaneous capital structures. In other words, fresh capital buys assets priced for the new environment and benefits from lenders that have already re-priced credit.
Properly underwritten deals today typically feature lower leverage, higher equity cushions and loan terms that reflect current market realities. For long-term investors that can tolerate illiquidity, that profile can be acceptable or even attractive relative to comparable public equity exposures.
Finally, under normal market conditions, the risk difference between private and public equity is small once one controls for country and industry. The current divergence is therefore largely cyclical. What matters now is underwriting discipline and a clear distinction between legacy debt-laden portfolios and freshly deployed private capital.
Blake Wolfe is the managing editor of Benefits Canada and the Canadian Investment Review.