CFA vs CAIA: What Studying Both Markets Reveals About Complementarity

The Margin, Finally Filled

Fermat’s Last Theorem stated that no whole number solutions exist to the equation:

$$
a^n + b^n = c^n \text{ for } n > 2, \\[1.5em]
\text{where } a, b, c, n \text{ are positive integers.}
$$

In 1637, Pierre de Fermat scribbled in his margin: “I have discovered a truly marvellous proof, which this margin is too narrow to contain.” It took 358 years, and mathematics Fermat never knew existed, for Andrew Wiles to prove him right in 1995.

Finance has its silos. CFA for public markets. CAIA for private markets. Each domain gets its own certification, its own expertise, its own floor in the building.

But studying both reveals something the silos obscure: Public and private markets don’t merely coexist. They are interdependent in ways that reshape both.

Like Fermat, I’ll resort to postulating without unequivocal proof. What follows are some observations from crossing the divide – my scribblings in the margins.

Not CFA vs CAIA, but CFA & CAIA.

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The Silo Problem

Many large asset owners treat public and private markets as separate asset classes requiring distinct skillsets and separate departments, maybe even on separate floors. This physical division breeds parallel cultures with little interaction. Critical information gets lost in organizational friction.

The pattern is depressingly familiar. Senior management hands down an allocation split from above, say 60% public, 40% private. Each department then optimizes within its own domain, achieving exposure to strikingly similar investment risk. An “us” versus “them” culture emerges – like two warring tribes within the same company.

This misses the point entirely. Public and private investments represent the same fundamental risk factors: equity risk in companies, credit risk on counterparties. Only the structures differ. The question isn’t which is better, but how they complement each other.

Yet complementarity requires what most organizations actively prevent: professionals who inhabit both worlds.

Public market investors who appreciate the dynamics of private markets recognize how private capital reshapes the investable universe, exerting pressure on pricing by altering supply or removing investment options from the public domain. Conversely, private market investors who understand public markets acquire analytical rigor and a keener sense of opportunity cost.

The stairs between floors should be crowded. Instead, they are remarkably empty.

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Public Markets → Private Markets: Bringing the Yardstick

Public markets experience is undervalued and underestimated in assessing private investments. The siloing means apples-to-apples comparisons are too often neglected. This costs investors dearly.

The IRR Illusion

Some renowned private equity firms tout Internal Rate of Return (“IRR”) figures in the mid-20s to high-30s (gross returns since inception). Yet IRR – essentially an estimate of an investment’s average annual growth rate based on its specific sequence of cash flows – doesn’t measure what most people think.

IRR measures something useful for private equity fund managers: it captures the implied average growth rate of capital given the specific timing of when money goes in and out. But it’s terrible for comparing performance across investments with different cash flow patterns, and especially misleading when compared to public market returns.

As Ludovic Phalippou, Oxford professor and leading private equity expert, wrote in the Financial Times (1):

“Internal Rate of Return is a powerful tool — but it’s not a rate of return. It is a mathematical artefact… not realistic, not additive, not comparable to market indices.”

One might add that IRR’s fundamental limitation lies in its dependence on timing of cash flows. It yields one composite return figure overwhelmingly determined by initial flows, making it increasingly unresponsive to later data, and most critically: doesn’t accurately reflect how capital compounds over time.

Time-weighted returns, or TWR, is the standard for public markets. TWR weights each period equally rather than by the amount of money invested. This is why TWR and IRR often diverge dramatically when cash flows are irregular, which is common in private equity.

The IRR Illusion is testament to the silo problem. IRR should never be used in direct comparison with public market asset returns. Many accept these figures without performing this elementary sanity check, mistaking this “mathematical artifact” for actual wealth accumulation.

Consider what these reported IRRs would imply if they represented actual compound growth. As Phalippou points out, one prominent firm reports a 26% IRR since inception some 40 years ago. If that reflected true compounding, an initial investment of 10 million (without further contributions or distributions) would have grown 10.000-fold to 100 billion today! (2)

Obviously, nothing of that sort has happened.

KEY TAKEAWAY #1: Don't use IRR for performance comparison with public markets. It's a mathematical artifact, not actual compounded wealth.

The Data Frequency Problem

Public markets provide daily marks. Private markets follow the quarterly rhythms of accounting. Many attempt to force this square peg into a round hole through “unsmoothing” techniques that whip life into private returns to match public market frequency.

This replaces one problematic metric (IRR) with another technique also built on assumptions (unsmoothed returns). It’s false comfort, and probably wrong.

As the saying often misattributed to Keynes goes:

“Better to be roughly right than precisely wrong”

Warren Buffett’s former partner Charlie Munger, however, offered better advice:

“Invert, always invert.”

Instead of forcing private returns to jitter, long-term investors should do the opposite. Evaluate private returns on much more infrequent basis (at least yearly horizons or rolling three-year periods) to get a truer picture of value added.

KEY TAKEAWAY #2: Don't evaluate private markets too frequently. Reduce frequency to yearly or three-year rolling periods for more meaningful comparable measures.

What yardstick?

To evaluate individual private investments, the right measure is Public Market Equivalent (PME) – essentially, did this fund beat public markets? But here’s where public markets experience proves invaluable: What’s the sensible benchmark?

Does it make sense to evaluate a concentrated US small/mid-cap focused buyout fund against a global stock index, let alone the S&P 500? Should you account for leverage and illiquidity by adding risk premia to the public “equivalent”?

If you can replicate a buyout fund’s returns using publicly available instruments with similar risk characteristics, that should make you think twice about tying up capital in such vehicles.

Morningstar’s 2025 PitchBook Buyout Replication Index demonstrates that publicly traded small-cap stocks selected using AI to mirror private equity characteristics can deliver PE-like returns with full liquidity and transparency. (3)

PGIM research reveals that micro-cap equities match or exceed private equity performance while eliminating the substantial fee drag and capital lock-ups, with private equity’s real-world volatility nearly double its reported figures. These liquid alternatives provide PE-style exposure without the traditional constraints of illiquidity, smoothed valuations, or management fees. (4)

When funds claim they created value through operational improvements by buying at 8x EBITDA and selling at 12x, ask what happened to comparable public market multiples over the same period. If those expanded from 10x to 14x, the fund didn’t create (independent) value. It rode a wave.

The concept of opportunity cost is vastly underestimated. What else could you have done with that capital? My opportunity costs differ from yours given our different investment horizons. Having range in investment knowledge enables better reflection on what the true alternative is.

KEY TAKEAWAY #3: Use PME with judgment about true opportunity costs. Don't tie up capital or pay high fees for exposure you can replicate publicly. Seek funds offering true complementarity.

The Stuck Hurdle Rate Problem

Many private market funds use fixed hurdle rates to evaluate performance and charge fees accordingly. Typically, around 8% (the rate many funds charge their performance fees above), these rates persist regardless of broader market conditions. This makes no sense.

When risk-free rates swing from 0% to 5.3% (as they did between 2021 and 2023), a fixed hurdle rate disconnects performance measurement from economic reality. An 8% return when Treasury bills yield 0% represents genuine excess return. The same 8% when Treasuries yield 5.3% barely clears the hurdle—you’re earning just 2.7% above risk-free rates for tying up capital for a decade. An investor might find 2.7% excess returns in the public bond markets offered with instant entry and exit opportunities at arguably much lower risk.

It’s like a coffee shop charging $6 for a latte when gas station coffee costs $2. That $4 premium feels justified for quality and ambiance. But when an equally good specialty shop opens across the street charging $5, your original shop’s value proposition relative to your alternatives has collapsed even though its price hasn’t changed.

Public markets provide the discipline here. Equity benchmarks naturally adjust for interest rate environments through valuations. Credit spreads, widen and tighten relative to risk-free rates. Private markets, insulated from daily marks, ignore this reality.

The hurdle rate that made sense in 2021 makes little sense in 2025. But investors rarely renegotiate these terms, and managers rarely volunteer to adjust them. Fixed hurdle rates ignore opportunity costs systematically. Public markets experience teaches you to ask: what’s the relevant comparison? Private market structures too often avoid the question entirely.

Squaring the Circle

These messages point toward a coherent framework. At the individual fund level, proper assessment requires triangulation across multiple metrics:

• Public Market Equivalent (PME): Did this fund beat public markets using a relevant benchmark?
• Total Value to Paid-In (TVPI): How much did your money multiply?
• Distributions to Paid-In (DPI): What’s actual cash returned versus paper promises?

No single metric tells the complete story. TVPI includes unrealized valuations that may prove optimistic. DPI excludes future potential. PME depends entirely on benchmark selection and time period. Together, however, they triangulate truth.

At the aggregate level, investors with diversified exposure should translate private returns to quarterly linked annualized Time-Weighted Return comparables. Think of it this way: private funds report values four times yearly. Linking those quarterly snapshots creates a growth rate you can compare directly to stock indexes, no conversion tricks needed.

Trying to fit private markets into public frameworks requires care. Use the wrong tools and you force square pegs into round holes. But with proper methodology, the comparison becomes meaningful rather than misleading.

Public markets provide the yardstick. The question is whether private market investors choose to apply it properly.

The ESG Accountability Gap

The silo problem becomes particularly costly in sustainability assessments. Public companies face relentless transparency on ESG (environmental, social, and governance) matters. Disclosure requirements, and reputational risk create discipline.

Private markets, despite offering superior governance positions and operational control, face remarkably less accountability on the same issues.

The Decarbonization Opportunity

The irony runs deep. Traditional buyout targets (mature companies operating under the radar) often represent the lowest cost decarbonization opportunities available. A great many haven’t invested meaningfully in transition yet, implying marginal improvement costs run far lower than for scrutinized large-cap public companies that already acted under pressure.

This makes private markets potentially the best venue for cost-effective, real-world decarbonization. By taking ownership of companies in early transition stages, investors can deploy low-cost capital where it achieves maximum impact.

Yet despite superior governance positions and operational control, private markets face remarkably less ESG accountability. Opacity masks underperformance. Aside from venture capital and impact investing that work towards creating tomorrow’s solutions to important social and environmental challenges, today’s most cost-effective improvements sit in the traditional buyout space, precisely where ESG scrutiny remains weakest despite investors having the most control.

If private market investors genuinely have superior governance positions through board control and operational influence, they should demonstrate superior ESG outcomes. Public markets provide the transparency discipline private markets desperately need.

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Private Markets → Public Markets: The Interference Patterns

Understanding private markets doesn’t just inform private market decisions. It explains puzzles in public markets that traditional analysis easily overlooks. Consider two cases where private markets prove to be the hidden variable.

The Great Small Cap Heist

US small caps have underperformed large caps dramatically since 2010 despite trading at historically cheap valuations. Traditional explanations around interest sensitivity or quality deterioration prove insufficient.

BCA Research uncovered the mechanism in their 2024 special report: “The Great Small Cap Heist: How Venture Capital And Big Tech Stole America’s Best Small Companies.”

Historically, small cap outperformance came from ‘migration’: successful small companies growing large enough to enter the large-cap index. Strip away migration and small caps actually underperform.

Migration rates have collapsed from roughly 4.5% of small-cap market capitalization around 2000 to approximately 2.5% today. The companies that would have grown into successful large caps no longer stay public or enter the public markets. (5)

Venture capital keeps promising companies private longer, with late-stage valuations now regularly exceeding the Russell 2000 threshold. Companies enter public markets already classified as large caps, if they go public at all. Big Tech accelerates this through acquisitions, buying promising firms before they become independent large caps.

As BCA notes: “Only the very worst companies are left in the small cap space.” According to Apollo Chief Economist Torsten Sløk, some 40% of Russell 2000 companies now have zero or negative earnings, up from below 20% two decades ago. (6)

You cannot understand small cap underperformance through public market analysis alone. Private markets have systematically removed the highest-quality companies from the public small cap universe.

This helps one understand why there is no guarantee of small caps outperforming large caps when looking ahead, even though that was historically observed.

The Credit Spread Puzzle

High-yield spreads remain remarkably tight despite elevated uncertainty, and recession concerns. Rick Bookstaber, thought leader on risk management, identified the culprit (7):

“Private credit has flooded the market, pushing risk premiums down even as the level of risk has gone up. Abundant supply creates the appearance of stability and liquidity. But it is an illusion.”

Companies that would historically have issued high-yield bonds now turn to direct lenders. Private credit has exploded from negligible amounts to over $1.5 trillion today, removing supply from public markets and compressing spreads beyond what fundamentals justify. But as Bookstaber warns:

When investors can’t sell what they want to sell, they sell what they can. That’s how contagion begins.”

You cannot understand public credit spreads without understanding private credit flows. The private credit markets interfere and currently exert a pull away from the public credit markets.

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Same Same, But Different

As they say in Thailand: “Same same, but different!”

The underlying economic risks are the same: equity risk in companies, credit risk on counterparties, exposure to sectors and cycles. Strip away the structures and you find the same fundamental uncertainties.

The vehicles, however, are very different: listed shares versus limited partnership interests, bonds versus direct loans, daily liquidity versus monthly redemption features or even decade-long lockups.

These structural differences create divergent risk profiles even when economic exposures match. Capital locked in illiquid vehicles cannot be redeployed when public markets hit fire-sale prices (like early 2020, when public equities fell more than 30% in a month while private funds held steady valuations and offered no chance to buy the dip). The missed opportunities don’t appear in return calculations but represent real costs, nonetheless.

Flexibility has value. Illiquidity has cost. Too many private investments don’t justify the trade.

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The Double Helix

James Watson, recently diseased co-discoverer of DNA’s double helix, created the perfect metaphor to public and private markets: two strands, gravitationally connected, constantly arbitraging each other.

When public markets become cheap, capital flows to private markets who take public companies private through leveraged buyouts (LBOs). When public markets become expensive, capital flows public through IPOs. When spreads widen or valuations diverge, arbitrage occurs through vehicle transformation.

The strands don’t operate independently. They spiral around each other, each continuously reshaping the other. Asset owners who ignore this reflexivity make worse decisions in both markets.

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The Complementarity Test

The wrong question: Should I invest in alternatives?

The right question: What does this specific alternative do for this portfolio that public markets cannot do as well, and does that benefit justify the opacity, illiquidity, and fees?

The costs prove substantial. Illiquidity locks capital for a decade, sacrificing optionality. Opacity limits transparency. Fees run significantly higher. Complexity requires extensive infrastructure. For alternatives to justify these costs, they must provide genuine differentiation.

Where Complementarity Works

Private markets justify their higher costs when they solve problems public markets cannot.

Impact investing requires operational control to achieve genuine additionality (change that occurs because of, not merely alongside, your investment). Private ownership creates this causal link. Your capital and governance influence drive measurable outcomes.

Public market ESG investing lacks this mechanism. Purchasing shares in an established company likely contributes nothing to its sustainability trajectory, which unfolds independently of your ownership. Investor engagement offers a potential exception (using shareholder influence to push for change), but establishing genuine causality proves difficult. Did your advocacy create the change, or would it have occurred regardless?

Patient capital, freed from quarterly earnings tyranny, enables transformations public markets would strangle. Projects requiring five-to-ten-year horizons can mature without the premature judgment that public scrutiny imposes.

Venture capital occupies its own complementary territory, funding innovation too early or too uncertain for established companies to pursue. Some asset classes remain genuinely scarce publicly: infrastructure with inflation-linked revenues, farmland, timberland.

For long-horizon taxable investors (family offices being the clearest example), private markets offer tax efficiencies structurally absent from public securities. Illiquidity becomes an advantage: the inability to trade defers capital gains realization across years or decades. Infrastructure generates depreciation that shelters income. Real estate qualifies for accelerated depreciation schedules. Timber and farmland receive preferential capital gains treatment. These tax shields can make after-tax returns for private holdings far superior for buy-and-hold investors willing to forgo liquidity.

The limited liability structure contains downside risk. Losses remain isolated within the investment itself rather than cascading through margin calls. Public securities offer no such firewall. Volatility can force portfolio-wide liquidation in distressed markets.

This protection carries a price. Private holdings cannot readily serve as collateral, raising financing costs. More fundamentally, the structure demands genuine patience: only investors who can forgo liquidity and withstand the opportunity costs should participate.

Otherwise, if an investment is economically equivalent to public markets, why pay high fees for illiquidity and opacity?

Measure rigorously. Insist on true differentiation.

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Tools, Not Answers

A CFA charter teaches public market analysis. A CAIA certification covers alternatives. Neither guarantees success.

Education gives tools. Experience gives judgment.

But distinguishing genuine complementarity from fee extraction requires visiting both floors: understanding public markets deeply enough to spot substitutes, private markets deeply enough to recognize genuine differentiation, and their interference patterns well enough to position portfolios appropriately.

In the aggregate, too many private investments charge high fees for little differentiation. But the exceptions matter. When private market alternatives solve problems, public markets don’t solve as well, they prove valuable.

It’s Complementarity All the Way Down

Charlie Munger was right: “Invert, always invert”. To understand public markets, study private markets. To evaluate private markets rigorously, understand public markets. To build portfolios that work, understand how they interfere.

As Fermat discovered, what seems straightforward often requires frameworks more sophisticated than initially apparent. His Last Theorem presented a beautifully simple postulate that became one of mathematics’ greatest puzzles, requiring 358 years and mathematical tools Fermat never knew existed to solve. (8)

Perhaps we’re meant to wonder: what was his “marvellous proof”? Some puzzles persist precisely because they shouldn’t have simple answers.

It’s complementarity all the way down.

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This post draws on recent research and thinking from leading practitioners and academics in both public and private markets.

References

(1) Ludovic Phalippou, “The delusion of private equity IRRs“, Financial Times, May 23, 2025.

(2) Ludovic Phalippou, “The Tyranny of IRR”, December 03, 2024

(3) Morningstar/PitchBook, “Taking the Private out of Private Equity, with the Morningstar PitchBook Buyout Replication Index” February, 2025

(4) PGIM study, “Micro Caps vs. Private Equity: Unshackle Your Returns”, April 2023

(5) BCA Research, “The Great Small Cap Heist“, May 29, 2024

(6) Torsten Sløk, Apollo Chief Economist, “40% of Companies in Russell 2000 Have Negative Earnings”, Apollo Academy, January 26, 2023

(7) Rick Bookstaber, “Why are credit spreads so tight?” LinkedIn post, November, 2025

(8) For the interested reader I recommend “Fermat’s Last Theorem” by Simon Singh (1997) to learn about the fascinating history and numerous failed attempts to solve this initial conjecture. Even the discovered of the proof, British mathematician Andrew Wiles, initially thought he had discovered the answer when initially publishing his “proof” after more than five years of research time. However, an error was later discovered in his “proof”, forcing Wiles to re-examine his work. Eventually, after more than 7 years work in total, Wiles published a correct proof in the journal Annals of Mathematics in 1995 as two articles amounting to 129 pages long.

1. This quarterly evaluation approach works for performance measurement but creates operational challenges for life insurers and pension funds serving active member bases. Members may need to transact on any given day due to contributions or withdrawals that cannot be pooled to quarterly NAV dates. To the extent possible, these institutions should avoid intra-quarterly transactions and limit member trading to validated quarterly marks. Why? Facilitating daily transactions forces modeling of interim NAVs using assumptions about private market valuations between official reporting dates. This raises a fundamental question: do open-ended fund structures truly serve long-term investors like pension members, or would closed-end structures without continuous in/outflows be more appropriate? Imposing liquid structures on underlying illiquid assets inevitably requires assumptions and modeling, creating potential for unintended wealth transfers between members who transact at different times. For genuinely long-horizon investors, is this redistribution risk worth bearing simply to maintain the illusion of daily liquidity? ↩︎

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Disclaimer: This post represents the personal views and opinions of Marc Olivier Dines and does not represent the views of any employer, institution, or organization with which I am affiliated. Nothing on this site constitutes investment advice, financial advice, or a recommendation to buy or sell securities.

These observations reflect my study of market structures, not commentary on any specific institution’s approach. Many sophisticated investors have developed frameworks that successfully integrate public and private markets. This piece explores conceptual challenges, not any particular organization’s solutions.

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