The Death Of Financial Engineering.
Feb 12, 2026
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Key Takeaways â–¶ Financial engineering drove ~50% of PE returns in the 1980s — today it contributes a fraction â–¶ 47% of value creation since 2010 now comes from operational improvements â–¶ Firms with strong operating teams command a 2-3% IRR premium in fundraising â–¶ The exit drought (6+ year holds) makes operational alpha the only viable return path |
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50% of PE returns from financial engineering in the 1980s |
47% of value creation now from operations |
6+ year median holding period |
There's a conversation happening in every PE firm right now. It's not about deal flow. It's not about dry powder. It's about how returns are actually generated — and whether the firm is structured to generate them.
For decades, the answer was financial engineering. Buy a business. Lever it up. Ride the cycle. Exit at a higher multiple. The capital structure did the heavy lifting. Operating teams, to the extent they existed, were advisory at best.
That era is over.
The macro shift is structural, not cyclical
ZIRP — the zero interest rate environment that powered a generation of PE returns — ended in 2022 and isn't coming back. Borrowing costs aren't temporarily elevated. They're structurally higher. The cost of leverage has turned what was once an arbitrage into a drag on returns.
This isn't a blip. Morgan Stanley's 2026 private equity outlook describes a “higher rate world” as the new baseline. Apollo's research frames it as a permanent recalibration of how returns must be generated.
The implications are significant. Financial engineering — which drove roughly 50% of PE returns in the 1980s and 1990s — now contributes a fraction of what it once did. The lever that defined the industry for three decades has been dulled.
The data on where value actually comes from
The shift from financial engineering to operational value creation isn't a prediction. It's already happened.
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47% of value creation in PE portfolios since 2010 has come from operational improvements Source: BDO, 2026 PE Predictions |
Revenue growth accounted for 71% of exit value in 2024. And 64% of PE firms now rank margin growth as their number one value creation driver.
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“As leverage and multiple arbitrage fade... the remaining path to premium returns is through the relentless pursuit of building better businesses.” — Moonfare |
The era of financial engineering, as one industry analysis framed it, “has largely ceded ground to a mandate of operational engineering.”
These aren't edge cases. This is the centre of gravity.
The exit drought compounds the problem
The shift to operational value creation would matter even in a healthy exit environment. But the exit environment isn't healthy.
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6+ years Median PE holding period — up from 3-4 years a decade ago. The distribution drought has locked exits. Source: Morgan Stanley, 2026 PE Outlook |
LPs are sitting on unrealised IRR but minimal DPI (cash returned). Fundraising pressure is mounting on 2020-2022 vintage funds.
This changes everything about how firms create value. You can't wait for multiple expansion when you're holding for six years. You can't rely on financial engineering when rates make leverage expensive. The only path is to create real, measurable operational value inside the business — and to do it fast. 85% of PE firms are now pushing AI adoption across their portfolios for precisely this reason. AI is the tool that makes operational value creation fast, systematic, and scalable.
What this means for operating partners
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1. Operational capability is now a fundraising requirement LPs aren't just asking about deal sourcing. They're asking about operating teams, value creation track records, and portfolio monitoring infrastructure. Firms with strong operating teams command a 2-3% IRR premium, according to KPMG research. |
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2. Speed matters more than ever — and AI delivers it With longer holds and exit pressure, the 100-day plan has become the most critical document in portfolio management. Firms need to demonstrate operational impact within months, not years. 41% of PE leaders say AI’s greatest impact is speed to execution. AI-driven operational intelligence can be deployed in weeks, not quarters — identifying at-risk revenue, surfacing margin opportunities, and accelerating decisions from day one. Speed-to-EBITDA determines whether you raise the next fund. |
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3. AI-driven playbooks beat one-off interventions The best firms aren't running ad hoc improvement projects. They're building systematic, AI-driven value creation capabilities that deploy across every portfolio company. 70% of PE firms are increasing AI investment by 25% or more in the next 18 months. The firms deploying AI as operational infrastructure — not as a technology experiment — are the ones where the advantage compounds across the portfolio. |
The firms that get this are already acting
Cerberus has built COAC — a proprietary affiliate with 110+ full-time operating executives. Apollo has built APPS — a centralised data and AI platform. Platinum Equity embeds operations into the deal team from Day One with their M&A&O model.
These aren't experiments. These are industrialised AI-driven operating capabilities. Apollo's APPS platform uses AI for cross-portfolio benchmarking and intelligence. These firms have understood that AI is the infrastructure through which operational alpha is manufactured at scale.
For mid-market firms without $500bn in AUM, the path forward looks different. It's not about building a 100-person ops division. It's about deploying AI-driven operational intelligence that delivers the same depth of insight — revenue protection, margin expansion, decision acceleration — in weeks, not years.
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Case in Point We recently deployed Order Book Intelligence for a European industrial distributor. Six weeks from kickoff to a working system that identified EUR 45m in at-risk revenue. Not a pilot. Deployed, working, generating value. That's what operational alpha looks like in practice. |
The bottom line
Financial engineering isn't coming back. The macro conditions that powered it are gone. The firms that raise the next fund — and the next — will be the ones that can demonstrate operational alpha: measurable value created inside the business, not extracted from the capital structure. And the fastest, most scalable way to create that value is AI-driven operational intelligence deployed directly against the metrics that move EBITDA.
The question isn't whether this shift is happening. It's whether your firm has the AI-driven operating capability to capitalise on it.
Sources & References
| BDO — 2026 Private Equity Predictions — 50% financial engineering returns (1980s), 47% operational value creation (since 2010) |
| Apollo Global Management — PE Outlook — 71% of 2024 exit value from revenue growth, “higher rate world” thesis |
| Morgan Stanley — 2026 Private Equity Outlook — 6+ year median holding period, structural rate environment |
| KPMG — PE Value Creation Research — 64% rank margin growth as #1 driver, 2-3% IRR premium for operating teams |
| Moonfare — “Building Better Businesses” — Shift from leverage to operational value creation |
| CLA Connect — PE Firms and AI Adoption — 85% of PE firms pushing AI adoption across portfolios |
| Bain & Company — PE AI Investment Research — 70% increasing AI investment 25%+ in next 18 months |
Frequently Asked Questions
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What is financial engineering in private equity? Financial engineering in private equity refers to the use of leverage (debt), multiple arbitrage, and capital structure optimisation to generate investment returns. It drove roughly 50% of PE returns in the 1980s and 1990s according to BDO research. Since interest rates rose structurally from 2022, financial engineering has become significantly less effective as borrowing costs turned leverage from an arbitrage into a drag on returns. |
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What percentage of PE value creation comes from operational improvements? According to BDO's 2026 PE Predictions report, operational improvements have generated 47% of value creation in PE portfolios since 2010. Revenue growth accounted for 71% of exit value in 2024 according to Apollo's PE Outlook, and 64% of PE firms now rank margin growth as their number one value creation driver according to KPMG research. |
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What is operational alpha in private equity? Operational alpha is measurable EBITDA uplift delivered through systematic operational intervention in portfolio companies. It includes revenue protection, margin expansion, and efficiency improvements. Unlike financial engineering which extracts value from capital structures, operational alpha creates value by building better businesses. KPMG and Moonfare research shows firms with strong operating teams command a 2-3% IRR premium in fundraising. |
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How long is the average PE holding period in 2026? The median PE holding period has extended past six years in 2026, up from 3-4 years historically, according to Morgan Stanley's 2026 Private Equity Outlook. This extension is part of the distribution drought, where exit windows have narrowed and LPs are receiving limited cash distributions from 2020-2022 vintage funds, shifting focus from IRR to DPI. |
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What is the PE distribution drought? The PE distribution drought is the extended period where private equity firms have struggled to return capital to their limited partners (LPs). Median holding periods now exceed six years, exit windows are narrow, and LPs sit on unrealised gains with limited cash returned. DPI (distributions to paid-in capital) has overtaken IRR as the key metric LPs use to evaluate fund performance and make allocation decisions. |
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Why are PE firms building larger operating teams and investing in AI? PE firms are building larger operating teams and investing in AI because operational capability has become essential for generating returns in a high-rate environment and for raising capital from LPs. 85% of PE firms are pushing AI adoption and 70% are increasing AI investment by 25% or more in the next 18 months (CLA Connect, Bain). Cerberus built COAC with over 110 full-time operating executives, Apollo built APPS as a centralised AI and data platform for cross-portfolio intelligence, and Platinum Equity embeds operations into deal teams from Day One. Mid-market firms are deploying AI-driven operational platforms to achieve similar capability at a fraction of the cost. KPMG research shows firms with strong operating teams command a 2-3% IRR premium. |
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How does AI create operational value in PE portfolio companies? AI creates operational value in PE portfolio companies by deploying working intelligence systems that protect revenue, expand margins, and increase efficiency. 85% of PE firms are pushing AI adoption across their portfolios and 41% of PE leaders say AI’s greatest impact is speed to execution. AI analyses order patterns, customer behaviour, and operational data to surface risks and opportunities invisible to manual analysis. One deployment of AI-driven order book intelligence at a European industrial distributor identified EUR 45m in at-risk revenue within six weeks. The key is deploying AI as production operational infrastructure in weeks, not as technology pilots that never scale. |
This is Part 1 of an 8-part series on the structural shift from financial engineering to operational value creation in private equity. New articles publish weekly through April 2026.
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