An Oxford-Said Business School study this week demonstrated that private equity returns have not been higher than public equity returns over the lengthy period since 2006. Similar studies have shown that hedge fund returns, theoretically not correlated to equity returns, have also grown increasingly inferior. Since both types of investment have created new billionaires from nowhere, we are forced to ask: what in heavens name do pension funds and other investors think they are doing investing in them?

The study: “An inconvenient Fact: Private Equity Returns and the Billionaire Factory” by Ludovic Phalippou, looks at a large dataset of private equity funds established between 2006 and 2015, and shows that their return was 11% per annum, equivalent to that of the Standard and Poor’s 500 Index over the period. However, the private equity funds during that period generated $230 billion in “carry” fees for their sponsors, making them far more expensive than any conventional equity investment. Furthermore, they were generally far more leveraged than ordinary public equity funds, so in an era when interest rates were low and generally declining, their return on equity was further artificially inflated by their cheap debt.

That information does not stop institutions investing in the sector. In an interview published several days after the Oxford-Said study, Ben Meng, chief executive of the gigantic California public pension fund Calpers, explained that he intended to meet Calpers’ aggressive return targets (necessary for the fund to be able to pay the bloated pensions promised to the California public sector) by buying private equity positions and leveraging them, thus adding a third layer of debt to those of the private equity funds themselves and the companies in which they invest.

This strategy has been tried before. The Goldman Sachs Trading Corporation, a $100 million fund formed in December 1928 to invest in other companies using Goldman Sachs insights, merged with the Financial and Securities Corporation, then launched the Shenandoah Corporation and the Blue Ridge Corporation, all of these entities being cheerfully leveraged and heavily invested in each other’s shares. By February 1929, aided by some stock purchases of itself (this being permissible before the SEC was formed and again after 1982) GSTC had turned $100 into $222.50. Alas, by 1932 it had turned that $222 into around $1. GSTC had the best names on its board, including John Foster Dulles, and was the subject of a famous witty book by J.K. Galbraith in 1954. Were Galbraith alive today, he would have fun with private equity – or would he? – as a well-connected liberal Democrat he would be good friends with most of its titans and would approve of today’s monetary policy, which is the principal cause of their wealth.

In the 1960s through the 1980s, when they first came into existence, hedge funds and private equity funds both performed a useful economic function and earned above-market returns from doing so. Hedge funds took advantage of investment opportunities that were not available to retail investors because of SEC rules; they also profited from market anomalies that could be detected and exploited using computer modeling. Private equity companies sought out the many companies whose stock prices had fallen far below their asset values, often because of the galloping inflation and slumping stock prices of 1966-82. They then used simple cost-cutting and financial engineering to make outsize profits.

During the period before 1990 in which the amount of money invested in hedge funds and private equity funds was modest, if you avoided the obvious crooks you could do very well indeed by devoting part of your portfolio to the sector. That was the original inspiration behind the “Yale Model” of institutional investment developed by David Swensen after he became chief investment officer of the Yale endowment in 1985. However, the period of superior returns ended around 2000 and was certainly over after the crash of 2008.

The main reason for the success of private equity funds and hedge funds is overrated is selection bias. Only those funds that do well in their early years go on to attract large amounts of money, and their annual returns are then flattered by the returns in the early years when little money was involved. Indeed, some hedge funds deliberately set up multiple small fundlets, the successful ones among which can then be used in marketing to attract new money. Phalippou notes this problem with private equity returns, that the fat returns of the early years can be matched with market returns in the later years with more money involved to give overall apparently successful investment performance.

The best illustration of the problem is the career of Warren Buffett. In his early years, Buffett was a good Republican – he was after all the son of Rep. Howard Buffett, Republican Congressman from Nebraska’s 2nd District, 1943-49 and 1951-53. Howard Buffett (1903-64) was an isolationist libertarian, a friend of Murray Rothbard, who was convinced for many years that the U.S. was largely responsible for the outbreak of the Korean War. His son Warren, during his Republican years, achieved superlative investment results, becoming a billionaire in 1990. Then in 1991, he invested in Salomon Brothers, the investment bank, itself a good investment (he got extremely favorable terms), but it brought him into contact with the limousine liberals of Wall Street.

From that point onwards, Buffett’s investment superiority decayed as his politics moved leftwards. For the last decade, he has consistently identified as a liberal Democrat, and his investments, now of gigantic size in Berkshire Hathaway (NYSE: BRK-A) have consistently underperformed the market. Nevertheless, because of Buffett’s success in earlier years, when much less money was involved and his views were sounder, his overall return on investment, either since 1957 in his partnerships or since 1965 in Berkshire Hathaway, remains superior and he retains his reputation as an investment genius. This is a classic illustration of how early success is used to draw investors into hedge funds and private equity funds long after that success has ceased.

Several factors point to still worse underperformance by hedge funds and private equity funds in the years ahead. Over the last 25 years, they have had an exceptionally favorable environment, with stock prices rising and debt becoming cheaper and cheaper. That environment is now likely to darken, and as the entities most exposed to the joys of leverage and a rising market, hedge funds and private equity funds will be correspondingly dinged.

The amount of money invested in such funds has also continued to increase, and in recent years, steps have been taken to allow ordinary retail investors to buy into them. That’s always a warning sign; when the smart money invites in the plebs, you know it’s only to unload their current holdings at an inflated price – see for example the Goldman Sachs Trading Company saga outlined above. The thrill of investing with the elites, which hedge funds and private equity funds give to dozy pension fund managers, will no longer exist.

When a wall of money moves into a sector, that sector is inevitably destined for inferior returns going forward. The Efficient Market Hypothesis that states there are no free lunches, flawed though it is, applies to hedge funds and private equity funds just as much as it does to public equities. Wise investors will avoid the sectors and avoid further enriching their already over-stuffed sponsors.