The Decline of Private Equity Returns and the Lessons from David Swensen's Yale Model

The private equity industry, once a cornerstone of institutional investing, is grappling with a confluence of structural challenges that have eroded its historic returns. From 2020 to 2025, the sector faced a perfect storm: inflation, geopolitical instability, and a rapid rise in interest rates that disrupted the capital-intensive model of leveraged buyouts. By 2023, global private equity fundraising had contracted by 24% year-over-year, and exit activity stagnated as sponsors struggled to monetize assets acquired at pre-pandemic valuations. Yet, as the industry teeters on the edge of reinvention, David Swensen's Yale Model offers a compelling blueprint for navigating fee pressures, structural shifts, and the growing appeal of alternative strategies like direct investing and co-investments.

The Structural Shifts in Private Equity Performance

The decline in private equity returns is not merely cyclical but structural. For decades, the sector thrived on cheap debt and the ability to deploy capital in overvalued public markets. But the post-2022 environment—marked by a 500-basis-point surge in U.S. interest rates—has upended this model. Entry multiples for buyouts have become harder to justify, and exit valuations have lagged behind historical averages. By 2024, the median age of unsold portfolio companies reached a two-decade high, with many sponsors forced to rely on partial realizations (e.g., dividend recapitalizations, continuation vehicles) to return capital to investors.

The data is telling: from 2000 to 2020, North American buyout funds delivered a median internal rate of return (IRR) of 15.5%, outperforming the S&P 500 by over 500 basis points. But this gap has narrowed in recent years. In 2024, as public markets rebounded (the S&P 500 hit the 96th percentile of its 20-year valuation range), private equity's outperformance waned. The industry's reliance on leverage and its inability to adapt to higher-cost environments have exposed vulnerabilities long buried under the veneer of alpha generation.

Fee Pressures and the Yale Model's Counterpoint

At the heart of the private equity conundrum lies the fee structure. The traditional 2% management fee and 20% carry—once justified by the complexity of managing illiquid assets—now feel archaic. With investors demanding more transparency and performance-based compensation, the industry is under pressure to restructure. David Swensen's Yale Endowment Model, which grew the university's endowment from $1 billion to $30 billion over 36 years, offers a stark alternative.

Swensen's approach was rooted in three principles: diversification into alternatives, alignment of incentives, and long-term patience. By allocating 25% of the endowment to private equity (and another 20% to real assets), Yale harnessed the inefficiencies of illiquid markets. But Swensen also insisted on co-investments and direct deals, reducing reliance on fund-of-funds and cutting out layers of middlemen. This strategy not only lowered fees but also allowed Yale to negotiate better terms with general partners (GPs), such as requiring managers to maintain meaningful economic stakes in deals.

The Yale Model's relevance today is undeniable. As private equity GPs face pressure to justify their fees, institutional investors are increasingly adopting direct investing and co-investments. These strategies bypass traditional fund structures, reducing overhead and improving returns. For example, in 2024, Yale's co-investment program accounted for over 40% of its private equity allocations, a shift that has since been mirrored by other endowments and sovereign wealth funds.

The Rise of Alternative Strategies

The growing appeal of direct investing and co-investments is not just about cutting costs—it's about reclaiming control. Traditional private equity funds often impose rigid timelines and limited flexibility, whereas direct investments allow investors to tailor their approach to specific opportunities. This is particularly valuable in a fragmented market where niche sectors (e.g., climate tech, AI-driven manufacturing) offer outsized returns.

Moreover, the rise of separately managed accounts (SMAs) and open-end funds—structures favored by the Yale Model—has democratized access to alternative assets. These vehicles provide greater liquidity and transparency compared to traditional closed-end funds, addressing a key pain point for limited partners (LPs). In 2024, global assets under management (AUM) in SMAs and co-investments grew by 18%, signaling a shift toward more agile and investor-friendly models.

Lessons for the Future

As private equity navigates its current crisis, the Yale Model offers three critical lessons:

1. Diversify Beyond the S&P 500: While public markets have rebounded in 2024, the long-term outperformance of private equity remains intact. Investors must balance exposure to both asset classes, leveraging the strengths of each.
2. Align Incentives: Fee structures must evolve to reflect performance, not just capital deployed. Requiring GPs to co-invest in deals and tying management fees to asset growth are steps in the right direction.
3. Embrace Direct Investing and Co-Investments: These strategies reduce fees, enhance transparency, and allow investors to capitalize on niche opportunities. For institutions with the operational capacity, direct investing is no longer optional—it's essential.

The private equity industry is at a crossroads. The days of relying on leveraged buyouts and inflated multiples are fading, but the demand for alternative assets remains robust. By adopting the principles of the Yale Model—diversification, alignment, and agility—investors can not only mitigate fee pressures but also position themselves to thrive in an era of structural change.

For those willing to rethink traditional models, the future of private equity may lie not in the old playbook of high fees and opaque structures, but in the disciplined, long-term strategies that once made Yale a legend.