Ep 2. Operational Alpha: Private Equity's Main Lever

In finance, alpha is the excess return on an investment relative to a benchmark,  the portion of performance that can't be explained by market exposure or beta alone. It's the measure of whether a manager actually outperformed, or simply rode a rising market. For decades, private equity manufactured alpha through cheap leverage and multiple expansion, buy at a discount, add debt, wait for the market to re-rate the asset, sell high. That playbook, which accounted for the majority of buyout returns through 2022, no longer works in a higher-rate, higher-multiple environment.

Operational alpha is what's replaced it: excess return generated not by capital structure or market timing, but by improving the fundamental performance of the underlying business — pricing discipline, procurement leverage, supply chain efficiency, commercial strategy, talent productivity. It's alpha built inside the portfolio company, not extracted from the deal structure around it.

This episode unpacks why operational alpha has become the primary source of returns left in PE. Buyout IRRs hit a post-2002 trough between 2022 and 2025, while top-quartile funds kept generating 24%, nine points ahead of the S&P 500. The data, from Bain's "12 is the new 5" framework to McKinsey's finding that operationally-focused GPs earn 2–3 points more IRR, points to one conclusion: the firms treating operations as genuine institutional capability are pulling away from the ones still treating it as a line in the pitch deck. We cover where the alpha actually gets made (e.g) procurement, revenue operations, AI-embedded infrastructure and what it means for ETA investors, portfolio company operators, and operations leaders trying to position themselves at the center of value creation, not the periphery of it.

Show Notes

• Buyout fund IRRs: 2022–2025 trough at 5.7% pooled — McKinsey 2026
• Top-quartile buyout IRR over past decade: 24% vs. S&P 500 at 15%, MSCI World at 13% — McKinsey 2026
• 59% of PE returns 2010–2022 came from multiple expansion and leverage — McKinsey
• PE holding period exceeds 6.7 years — longest since 2005 — McKinsey 2025
• 18,000+ unsold PE-backed companies; $3.8tn unrealized value — Bain 2026
• "12 is the new 5": 10–12% annual EBITDA growth now required for a 2.5x return — Bain 2026
• GPs focused on operational improvements achieve 2–3 pp higher IRR — McKinsey 100+ fund analysis
• 71% of value creation at exit in 2024 came from revenue growth — Gain.pro 2025
• 66% of PE leaders report AI benefits within 12 months, up from 34% prior year — FTI 2026
• PE firms with formal talent ROI measurement achieve 28% higher returns — PE Operating Excellence Forum
• Blackstone Portfolio Operations: 500+ professionals, 250 portfolio companies, $226bn revenue, 700k employees
• Top-quartile funds derive ~39% of returns from revenue growth and margin expansion vs. 61% from multiples/leverage — McKinsey 2025

Sources 

• McKinsey Global Private Markets Report (2026) 
• Bain & Company Global Private Equity Report (2026) 
• FTI Consulting Private Equity Value Creation Index (2026)
• KPMG "Value Creation in Private Equity" (2025)
• PwC Private Equity: US Deals Outlook (2026)
• Bain & Company Asia-Pacific Private Equity Report (2025)
• Value Creation Institute "PE's Compensation Crisis" ( 2026)
• Gain.pro Private Equity Value Creation Report (2025)
  
  

Operational Velocity is for education and general information only and is not investment, financial, legal, or tax advice, and nothing in it is a recommendation to buy or sell any security. The views expressed are the host's own, the company and figures discussed are drawn from public sources believed reliable but not guaranteed, and you should do your own research and consult a qualified professional before making any decision.

Transcript

SPEAKER_01 0:02

My leaders are born in the water room. I suppose I'm the shuffle in the bed of night. My leaders are brand before they left. Who built the ranch on the work ahead? Technology comes with the numbers, so I'm not a trend. The follow up is it the operating edge, the return on the work, not the financial head. One thing is true. The value is always built by you. Operational velocity.

SPEAKER_00 0:33

Hello, everybody, and welcome to the Operational Velocity Podcast. I'm your host, Gotham Bassoo. Today we're going to talk about operational alpha. Alpha is supposed to be the whole game in private equity. You raise a fund, you deploy capital, you beat the market, and you return the money. Simple. Except right now, the industry that has built its identity on financial genius is watching its returns crater. According to McKinsey's 2026 Global Private Markets report, buyout funds, IRRs, hit a post-2002 trough between 2022 and 2025, roughly averaging 5.7% on a pooled basis. So let that sink in for a moment. The SP 500 returned 15% over the same decade. The MCSI world returned 13%. So the funds that used to brag about access to cheap leverage and multiple expensure are now sitting on 18,000 plus unsold companies. That's 61% of buyout portfolios held beyond the traditional four-year horizon, equating to approximately $3.8 trillion with the T dollars of unrealized value, stuck, waiting, aging. So what separates the funds that are actually generating returns from the funds that are managing a slow motion disappointment? In my opinion, it's one word, operations. And it's not the ops as a buzzword in a slide deck, not a slide that says a hundred-day plan. I mean systematic, deliberate, measurable improvement in how portfolio companies generate revenue, manage cost, and scale efficiently. And that's what we're going to talk to about today: operational alpha, what it is, who has it, how it's built, and why the funds that can manufacture it inside a portfolio company are building the only sustainable competitive advantage left in private equity. So let's get into it. Let's start with the structural reality, because I think the numbers are striking enough that I want to walk through them carefully. Private equity as an ads class grew up in a very specific environment. And if you think about it, it's not really that old. From roughly 1985 to 2021, the conditions were almost favorable for the financial engineering model. Interest rates were at a 35-year downward trend. Asset multiples expanded almost continuously. Cheap leverage was available on nearly everything. And if you bought a business at eight times EBITDA, added some debt, waited five years while the market improved to 12x and sold, well, congratulations, you're a genius. Or you just had the tailwind that most LPs eventually realize wasn't skill. So that is the old math, and I'm going to argue why it has gone away. Between 2010 and 2022, there are some estimates that multiple expansion and cheap leverage accounted for approximately 59% of total buyout returns. So the majority of private equities alpha wasn't alpha at all. It was beta dressed up in a Seville Rose suit. Then 2022 hit, and the interest rates moved from then 500 basis points in the U.S. in about 18 months, and the debt got expensive. Entry multiples, which had peaked to at nearly 12 times EBITDA, came under pressure, the exit market froze, and suddenly firms that had been extracting returns from financial structure found themselves sitting on aging portfolio with no clear path to exit. So a couple of reports from some of the top consultancies. McKinsey reports that median buyout holding periods now exceed 6.7 years, and that's the longest since 2005. Bain, another consultancy, says that distributions to LPs as a percentage of net asset value remained at 14% in 2025, below 15% for the fourth consecutive year. And the same report states that fundraising fell 16% in 2025 to $395 billion, a fourth straight annual decline. This is a structural problem and not a cyclical blip. So in Bain's 2026 global private equity report, it says it plainly the industry has reached an inflection point. I think they said that they have a phrase I think is genuinely useful as a framing device for everything that we're discussing today. 12 is the new five. And here's what that means. In the 2010s, a typical buyout deal needed roughly 5% annual EBITA growth to generate a benchmark, 2.5x return over five years. Today, with higher borrowing cost, Bain puts them at 8 to 9%, elevated entry multiples and limited multiple expansion potential. That same deal now requires 10% to 12% annual EBITA growth every year sustained for the full holding period. That is not a modest ass. That's not run some operational improvements in year two. That's a fundamental rewiring of how you underwrite a deal and what you need to actually execute inside the portfolio company once you own it. And here's what's interesting because the performance gap is widening. And it's also interesting from a competitive dynamic standpoint, because the dispersion between the top quartile and the median PE returns has never been wider. There's some data that show the top quartile buyout funds generating 24% IRRs over the past decade, beating the SP 500 by 9 percentage points, and the MCSI by 11. Meanwhile, the 2015 to 2017 vintage funds are generally generating roughly 2% IRRs, only 2%. The same vintage period that was supposed to be the golden area of PE deal making. So ask the question: what separates the top from the median? In a world where leverage is expensive and multiples aren't expanding, it comes down to one thing. And that is the ability to generate operational value inside the portfolio company. Not to find it, not to buy it, and wait for the market to re-rate it. It's to build it. And McKinsey is unambiguous about this in their 2026 report, where, and I quote, operational value creation, which is often used to be more of a marketing narrative than a true institutional capability, is now likely to be the primary source of returns for GPs and their limited partner. That's a remarkable sentence coming from McKinsey because McKinsey advises literally every major GP on the market. When they say marketing narrative, they mean it. They've sat in the rooms, they've seen the slide decks, and they're saying the firms that treated operational value creation as a brand claim rather than a real capabilities, are the ones generating 2% IRRs on the 2015 vintages. So that is the macro context. Financial engineering is no longer sufficient, multiple expansion is no longer reliable, the era of cheap leverage is over for the foreseeable future. The only lever left, the durable, defensible, and repeatable lever, is operational improvement. So let's talk about what that actually means. When I use the term operational alpha, I want to be precise about what I mean, because it gets used loosely and it matters to be precise. Alpha in finance is a return in excess of a benchmark, a return that can't be explained by market exposure alone. In private equity, the benchmark is increasingly the public market equivalent. If you're not beating the S P 500 on a risk-adjusted basis, you're not generating alpha. You're just adding complexity and illiquidity to an index fund. So operational alpha is the portion of a fund's excess returns that come specifically from improving how a portfolio company operates. Not from buying cheap, not from adding leverage, not from selling into a hot market, but from making the business materially better at the things businesses actually do, which is generating revenue, managing cost, allocating capital, serving customers, and building teams. And there are three sources of operational alpha. And I'd like to distill it into what I call the three core mechanisms of operational alpha generation. The first is revenue uplift. This is growing the top line through better commercial strategy, pricing discipline, customer segmentation, channel optimization, and market expansion. This is not the grow the business as a vague ambition, it's a systematic identification of where revenue is being left on the table and a disciplined plan to capture it. Bain's 2026 report on Asia-Pacific PE markets found that GPs themselves rank top-line growth as the most important factor affecting exit returns, with roughly about 53% identifying it as the primary driver. But here's the uncomfortable truth. Only slightly more than half of the GPs surveyed actually achieved their top-line growth targets in more than 50% of exits. The intention is universal, but the execution is not. Procurement alone is a massive lever. Blackstone's portfolio operations function, which serves over $1 trillion in assets under management, runs a group purchasing consortium called Core Trust that leverages $500 plus billion in buying power across its entire portfolio. That is operational alpha through scale. And when you can move 250 portfolio companies across a single procurement consortium, the savings are immediate and real. And that, my friends, is not financial engineering, that's industrial leverage. And the third main core mechanism is operational infrastructure and platform capability. And this is a longer-term category and takes into account ERP implementations, data architecture, supply chain network redesign, talent development, digital transformation, so on. This is the work that takes longer to show up in the EBITA, but that creates a platform for sustained growth and dramatically more attractive exit story. BCG or Boston Consulting Group had a research that showed that improved demand forecasting alone can boost revenue 2-4%, while smarter supply chain planning can cut inventory levels up to 5 to 10%, and that improves margins by an additional 25 to 50 basis points. And so for a mid-market portfolio company running a hundred million dollar business, that's not a rounding error. That's millions of dollars of UBITA created at a better process design. If we go back to McKinsey's analysis of more than 100 PE funds with the post-2020 vintages, it's the clearest quantitative validation of everything I'm describing. Because their finding states that general partners that focus on creating value through asset operations achieve internal rates of return up to two to three percentage points higher on average compared with their peer. And two to three percentage points sounds modest until you remember that this is net IRR at the fund level, compounded over a multi-year holding period. And at that scale, that's a differential between the difference between a good fundraise and an exceptional one. And it's also the difference between your next fund closing over subscribe and closing with three LPs who are doing you a favor. The Value Creation Institute puts it even more starkly. Operational alpha now explains nearly half of buyout value creation in top performing funds. Nearly half. In a world where the other half is still fighting over multiples and leverage, the firms that have figured out how to systematically manufacture operational alpha are playing an entirely different game. So how do they do it? How do the top quartile funds actually build and deploy this capability? Let's get into the operating model. When I talk about operational value creation model at the top performing PE funds, I want to distinguish between what's real and what's theater. Because here's the truth almost every PE fund in the world has an operating partner capability now. Almost every fund's pitchbook features a section on value creation, and almost every management presentation from a portfolio company CEO starts with an operational improvement plan. The theater is absolutely everywhere. But what separates a fund's generating top quartile returns is their operating capability is a genuine institutional infrastructure, not just an afterthought. So let me give you the contrast. At the theater end of the spectrum, you have funds that hired one or two operating partners in 2019 because it was fashionable. And they gave them four portfolio company board seats each and asked them to add value without a clear mandate, a defined methodology, or a performance accountability. And these operating partners are often former CEOs or consultants who have domain knowledge, but no institutional framework for deploying it systematically across a portfolio. Now let's look at the real end. Blackstone portfolio operations. Over 500 professionals, a global team supporting 250 portfolio companies, generating $226 billion in annual revenue and employing 700,000 people. Functional centers of excellence in healthcare solutions, procurement and supply chain, data science and AI, talent operations, sustainability, and treasury and capital markets. The appointment of Rodney Zemmel, the former global head of McKinsey Digital as the global head of portfolio operations in 2025 is a signal about how seriously this function is now being resourced. That's not a PE firm with an operational capability. That's a PE firm that is an operational capability that also happens to invest. So based on the research across Bain, McKinsey, FTI, and KPMG, I'd characterize the top performing funds operational model around four main pillars. The first pillar is around front-loaded operational due diligence. The best fens don't wait until after close to start thinking about operational improvement. They conduct rigorous operational diligence in parallel with financial diligence, and they arrive on day one with a specific, quantified value creation plan. And it's really about clearly establishing the value creation objectives before the deal signing, not after, but before. And this means that the operational thesis is embedded in the deal model and the management team understands the expectations before the wire transfer clears. The second pillar is systematic methodology, not bespoke improvisation. The top funds have a repeatable playbook that can be adapted to different sectors and company profiles, but allows and follows a consistent logic. They know which levers to pull first, they know what the diagnostic looks like, and they know how to sequence interventions across 36 to 48 month value creation time horizons. And it's really a professionalized delivery of operational alpha, meaning it is systemized and not improvised. The third pillar is talent as a return driver. And there's some firms' research that shows that PE firms with a formal talent ROI measurement, meaning they actually quantify the return of hiring and developing specific people inside portfolio companies as achieving 28% higher overall investment returns. 28%, that's a staggering number. The firms that treat human capital with the same analytical rigor, they apply financial capital, outperform the firms that just treat it as HR. And the last and final pillar, number four, is around technology. And technology and AI specifically embedded into operational execution. And I believe this is the new frontier. And the FTI Consulting 2026 Value Creation Index, which is a survey of 555 senior PE leaders across 14 companies, which was recently released last week, makes it clear that AI is now accelerating the speed of operational value creation in a very meaningful way. 66% of PE leaders reported AI-related benefits within 12 months, up from 34% the prior year. That's nearly doubling in one year. And critically, the report notes that AI is the most effective when embedded into core operational and commercial initiatives and not just deployed as a standalone technology experiment. So let's look at the 12 is the new five framework because I think it is very specific operational implication that isn't always made explicit. If you need 10 to 12% EBITDA growth annually to generate a benchmark return, and the average hold period is now approaching seven years, that means you need to generate roughly 70 to 120% cumulative EBITDA growth over the holding period through operations, not through multiple re-rating, not through leverage. It's only through building a materially better business. And that's what Rebecca Barak, head of Bain's Global PE practice, means when she says deals that once delivered competitive returns with modest Ibita growth now require sustained double-digit growth. In PE's new upcycle, the winners will be those for whom up alpha generation is a habit, not an aspiration. I'll say that again: a habit, not an aspiration. And that phrase is doing a lot of work because a habit is systematic. It's embedded in how you underwrite deals, how you staff portfolio companies, how you set management incentives, how you run board meetings, how you measure progress, and how you build towards an exit. Aspiration is a slide, habit is a machine. I want to spend some time on something that the reports and surveys don't fully capture. And that's where operational alpha is actually generated at the granular level inside a portfolio company. Because when you read about operational value creation, Either in a McKinsey report or a Bain chart, it can kind of sound abstract. Revenue enhancement, cost optimization, operational infrastructure, these are categories. But alpha doesn't come from categories. It comes from specific interventions and specific parts of the specific business. So let me walk through the highest leverage areas based on what the data actually shows. Procurement is the underappreciated hero of PE value correction. And here's why. It generates savings in months, not years. Unlike revenue growth, which requires market development, sales hiring, and customer acquisition cycles, all of which take time, procurement improvements can hit the income state in the first quarter after implementation. The PWC 2026 PE outlook puts it well. Outperformance will increasingly be driven by operational improvement, sector specialization, and data-enabled transformation, not financial engineering. So for a mid-market company with $50 million in direct material spend, a 5% improvement in procurement effectiveness is $2.5 million of IBITA annually recurring. So if you capitalize that at 10X in an exit, that's $25 million of enterprise value created from better purchasing. And that's a real number. That's what procurement mastery looks like in a PE context. The supply chain redesign lever is related but distinct. In a world of reshoring tariff risk and deglobalization, there was a study that explicitly calls out pushing capital towards localization, where the portfolio company that has a resilient, optimized supply chain has a structural cost advantage and a risk profile that acquires will pay for at exit. Then you have revenue growth. And this is harder than cost management, but compounds differently and creates a more defensible exit story. In the Baines Asia Pacific data, GPs rank top-line growth as the primary driver of value exit. And 53% say it's the most important factor. And the private equity value creation report found that revenue growth accounted for 71% of total value creation at exit in 2024. So, what does operational revenue generation actually look like? It starts with commercial diagnostic work. Where is the business underpriced? Where is it leaving margin on the table? Which customer segments have the highest lifetime value and lowest churn? And how do you tilt the mix towards those? Which markets are adjacent and penetratable with existing product? What does a sales process look like? And where in the funnel is the value being lost? And that is not a marketing strategy. That is operational rigor applied to the commercial function. Pricing discipline alone, systematic analytics-driven pricing rather than relationship-driven or cost plus pricing, can expand gross margins by 50 to 250 basis points. And on a $200 million revenue business, that's meaningful. And the firms that are good at this don't outsource it to a consulting firm that parachutes in and leaves. They embed commercial excellence as a capability inside the portfolio company through the right VP of revenue or chief revenue officer, through pricing tools, through customer analytics infrastructure, so that the improvement is durable beyond the holding period. The third dimension of where operational alpha is made is digital infrastructure. And this is where the AI discussion becomes concrete rather than abstract. In FTI's 22026 survey, they found that 66% of PE leaders reported AI benefits within 12 months, representing a real shift from when we were just two years ago. The use cases that are delivering fastest are demand forecasting, inventory optimization, pricing models, customer segmentation, and back office automation. And for a mid-market industrial company, AI-driven demand forecasting is no longer a futuristic concept. It's a deployment decision. The margin improvement from a smarter inventory management can yield up to 25 to 50 basis points just from better supply chain planning. And it's available to any portfolio company that builds the right data foundation. But here's the operational reality that the report reports understate, and that's the digital infrastructure work is only valuable if the operational fundamentals are sound. You cannot AI your way out of a broken process. And you cannot implement a demand forecasting tool if the underlying data is unreliable. And you cannot build a pricing model if you don't know your actual cost structure. So the firms that are getting AI right in a portfolio companies are the ones that did not, that did the blocking and tackling first. And what that means is clean data, integrated ERP systems, clear process ownership, and then finally, then layering AI on top of the functional fundation. The firms that try to skip straight to the technology are the ones producing the majority of failed implementations. So everything we've covered so far lives in a world of large cap private equity. The Blackstones, the KKRs, Apollo's, the large firms that are running hundreds of billions in AUM with entire operational armies. But the dynamics apply arguably with even greater force at the mid-market and small cap level, where most entrepreneurship through acquisition investors and independent sponsors operate. And here's why. At the large cap, operational capability has already become table stakes. The megafunds are already fielding 500-person operating teams. The alpha opportunity from building that capability is partially arbitraged away by the competition. When you look at the mid-market or the lower middle market, companies doing anywhere between 1 to 5 million to up to 50 million e-bitta, operational sophistication is still genuinely rare. The founder who built a 30 million E-BITA business over 20 years didn't necessarily build a professional procurement function, and they didn't necessarily build a demand planning capability. And they probably didn't have any structured pricing strategy at all. The business exists and generates cash because the founder is extraordinary, not because the underlying operating system is optimized. So the gap is where ETA-style investors and serious operating partners create value. You are, in effect, the operating group. And if you do it well, you are generating operational alpha in a segment of the market where it is still genuinely scarce. So for the operational leaders in this audience, whether you're running a function inside a PE back company, considering a portfolio company operating role, or thinking about operating partner path, the implications are significant. The language of private equity is shifting towards you. This means the operation leader who translate their domain expertise into financial outcomes, who can quantify the beta impact of a supply chain redesign, who could build a business case for a procurement transformation, who could connect a process improvement to a value exit multiple, is the most valuable person in the room at a PE backed company. It's not the CB show folks, not the investments associate, it's the operator who understands how their work creates enterprise value. And that, my friends, is a skill set. And the good news is it's teachable. And it's increasingly the thing that gets operational leaders to the C-suite, to the board table, and to the kinds of carry arrangements that we are previously the exclusive domain of the deal makers. So let me close where the data leaves us. Private equity in 2026 is a maturing industry that has lost the tailwinds it grew up on. The firms that built their franchise on cheap leverage, easy multiples, and financial engineering are struggling. The firms that build genuine systematic institutional operating capability are generating 24% IRRs and raising oversubscribed funds. And the research is backing it up and it's unambiguous across every MAZER source we've covered today. Whether it's McKinsey, Bain, FTI, KPMG, or PWC, operational value creation is not a differentiator anymore. It's the baseline requirement. It's the question whether you fund your portfolio company, your operating role has a systematic capability to deliver it. 12 is a new five, and that's the math. But the math is telling you something deeper. The business of private equity has fundamentally changed. Returns are made, not found. Alpha is manufactured, not assessed, and the manufacturing floor is the portfolio company, not on the cap table. So three things I want to leave you with. Number one, if you're an investor at any scale, the operational capability question is now the central diligence question. Not what the sector sees or not what's the entry multiple. It's how specifically does this fund make portfolio companies operationally better? If they can't answer that with specificity, you have your answer. Number two, if you're building or running a portfolio company, any contracts, whether it's PE backed or otherwise, the highest leverage investment you can make right now is in the operational infrastructure. Procurement systems, demand planning, pricing discipline, commercial analytics, not because a PE firm told you, but because the data shows these investments compound into EV at a rate that financial restructuring alone cannot match. And number three, if you're an operations leader trying to position yourself in the PE ecosystem, start translating everything you do into the language of enterprise value. Every efficiency you create, every cost you remove, every revenue you lever you pull, express it into an e-bita impact in capitalized value, in exit multiple terms. That's the language that the boardroom speaks, and it's the language that will get you to it. So the best PE funds don't win on the spreadsheets anymore. They win on the shop floor. That's operational velocity for today. If this was useful, share it with an operator who needs to hear it. You've taken, if you've taken anything on around operational alpha, a case study, a counter-argument, a story from a portfolio company trenches, then please reach out. The best episodes on this show come from practitioners, not from reports. And I'll see you in the next one. Take care.

SPEAKER_01 34:24

One thing is true.