SUCCESS

Semiliquid fund managers must walk a tightrope when it comes to cash management. Too little cash, and they could face a liquidity crunch that forces the sale of hard-to-trade assets, potentially depressing investor returns. Too much, and they risk hampering results another way by diluting the extra returns illiquid securities are supposed to offer. Striking the right balance is easier said than done.In recently released research that digs into semiliquid, private asset-focused portfolios, I documented portfolio characteristics, holdings similarities, and the risks of the large software exposures taken on by many of these funds. But one of the simplest, yet most critical, data points in the report is the portfolios’ cash and cash equivalent (that is, money market funds) allocations. For example, the typical semiliquid private equity fund has roughly 15% of its assets in cash. Some of the higher cash balances reflect recent inflows that had not yet been deployed. Still, it is relatively common for semiliquid managers to set aside 10%-15% of assets in liquidity sleeves in which cash often plays a main role. Holding cash can be prudent, as these funds must meet investor redemption requests while trafficking in hard-to-trade assets. But prudence has a cost. Cash, while generally safe, doesn’t return much. In fact, in recent history, it was a negative-returning asset after accounting for inflation. For funds aiming to provide investors with better-than-public-market returns, holding a slug of cash means you have less money to put to work in higher-returning assets. Private credit funds get around this issue with leverage, which allows them to gain over 100% market exposure even while holding some cash. But private equity funds use fund-level leverage sparingly, which is wise because the uncertain timing of cash flows from investments makes leverage far more risky for them. As a result, cash is a bigger hurdle for private equity semiliquid funds. This unseen cash drag comes on top of what should be the more obvious headwind: fees. The average adjusted prospectus net expense ratio in the private equity Morningstar Category is a little over 3%, much higher than typical actively managed public equity mutual funds and exchange-traded funds. And don’t forget that management fees are charged on the cash balances, too. Currently, at least, money market funds yield more than the typical management fee. Still, investors should be mindful of what they’re paying a manager who keeps a chunk of their investments in cash. Traditional private equity drawdown funds have a generally competitive record with public markets, albeit less so recently and with wider dispersion. But most semiliquid private equity funds are fund of funds and charge additional fees on top of those collected by the underlying drawdown funds. And those drawdown funds carry virtually no cash. Thus, any historic illiquidity premium that may have been captured in the drawdown vehicles was most often achieved via lower fees and significantly less cash drag than what will be experienced in most semiliquid funds. High Fees and High Cash Compound on Each OtherSignificant cash drag and high fees mean semiliquid managers need to nail their investments. To test how much more a portfolio needs to earn to overcome these hurdles, I ran a simple experiment. I compiled the returns of the S&P 500 and the MFS US Government Money Market fund going back to 1975 as respective proxies for public equity and cash. I created a two‑asset portfolio where the cash allocations (5%, 10%, 15%, and 20%) earned the money market fund’s return each month, and the investors paid the average private equity fund’s 3% fee. Using those two data points, I reverse-engineered the gross return needed in the equity sleeve to match the Vanguard 500 Index’s return over rolling 10-year periods.As shown above, the fees and cash create a significant hurdle. Even a portfolio of 5% cash typically would have needed to generate around 4 percentage points of annualized excess equity returns just to match the S&P 500. At 20%, the hurdle jumps to a lofty 6-8 percentage points annualized. The combined cash and fee drag is larger than a naive sum-of-the-parts would suggest. First, cash positions raise the effective fee on equity, forcing it to generate even higher returns since a portion of the portfolio isn’t invested in the return-generating assets. On top of that, the fees and cash drag interact and compound over time, forcing even higher returns to break even with public markets, especially in strong public markets. Have Any Active Managers Generated Those Kind of Returns? How probable is it that these funds can clear these hurdles? To test that, I looked at the track records of public equity managers to see how often they cleared their category benchmarks by 3 to 7 percentage points or more annualized before fees over rolling 10-year periods. The data includes all active and inactive US-domiciled mutual funds and ETFs from the nine main Morningstar Style Box categories, the six main international equity categories, and the three main global equity categories. Together, that’s more than 7,000 funds and almost 1 million unique monthly observations since the start of 1980. These categories collectively account for about 85% of US active equity fund assets as of April 2026. As shown above, achieving high excess returns is not impossible, but the odds are slim, especially once the hurdle crests 5% annualized. In the ensuing 10-year periods beginning in the 1990s, a reasonable but still relatively small percentage of active funds did extremely well in the midst and fallout of the dot-com bubble. That momentum, though, quickly crashed once the global financial crisis entered the rolling periods. And since the crisis, truly big excess returns have virtually disappeared. As of March 2026, barely more than 1% of funds in the study topped their index by 5 percentage points or more annualized over the past 10 years. What If All Funds Are Benchmarked to the S&P 500? The above data is based on category indexes, which by definition tend to be similar to the funds in their categories, so it is not a huge surprise that big outperformance is rare. Benchmarking all funds against a broad market index like the S&P 500 instead should create more broad equity outperformance potential for funds that invest outside of strictly US large-cap companies (as private equity strategies do), even if they didn’t beat their own index or peers. As the data below shows, there was a spike in S&P 500-beaters in the late 1990s and early 2000s—the one period since 1980 in which the S&P 500’s rolling 10-year returns dipped below 5% annualized, even turning negative from the dot-com bubble’s peak through the depths of the global financial crisis. Outside of that rather unique window, though, active managers of any ilk investing across the globe struggled to achieve big success relative to what could have been had in the S&P 500. When the S&P 500 gained 10% or more annualized (which occurred in nearly two-thirds of rolling 10-year periods), less than 3%, on average, of all active funds beat the index by 5 or more percentage points before fees. Since the start of the millennium, that number dipped to less than 1%, on average. Remember, 5 percentage points of excess returns is about what a fund charging 3% fees and holding 10% cash has historically needed to match the S&P 500. The dour numbers, however, highlight a path to success for semiliquid private equity funds with high cash levels and fees, albeit a largely uncontrollable one: stylistic and structural tailwinds. Small-cap and value funds powered the spike in the late 90s and early 2000s, as they avoided the carnage of the bursting tech bubble. And traditional private equity strategies, after all, have similarities to small-cap and value investing. So, it is possible that market winds could shift to favor private equity semiliquid funds if the public market turned away from large-cap tech and began to favor other parts of the market, as it did in the wake of the dot-com bubble. But that’s a big if, and if that is the investment thesis, there are plenty of public equity managers who stand to benefit, too. Bottom Line: Excellence Is Required This is not idle speculation. Virtually all longer-dated semiliquid private equity funds (that is, those launched before 2020 whose records reflect a more mature profile) have trailed the S&P 500 since their launches, most by a significant margin. Private equity managers may argue for a more global benchmark like the MSCI World Index, and some probably have an academic case for that given their portfolio allocations. But let’s be honest: Private equity is typically marketed as a superior asset class, no matter the benchmark. And should private equity managers begin complaining about benchmark challenges, that is perhaps the clearest sign that public and private markets have truly converged, as lamenting about benchmarks is a favored pastime of active public equity managers. On account of their high fees and cash drag, over truly long-term horizons, most of these semiliquid private equity funds will need to be the rough equivalent of a top 5% public equity fund to beat a core equity benchmark like the S&P 500. They need to be exceptional in an industry in which exceptionalism is ephemeral.