To any private
equity firms thinking of exaggerating their performance to better raise a
new fund: Don’t bother.
“Sophisticated LPs are, on average, unlikely to misallocate capital.”While portfolio net asset
values (NAVs) are easy to distort due to their subjective nature, limited
partners (LPs) are not easily tricked by valuation manipulations, according to
a study by the National Bureau of Economic Research (NBER).
managers often boosted reported returns when attempting to raise money for new
funds, reported finance professors Gregory Brown, Oleg Gredil, and Steven
Kaplan. However, these managers were unlikely to succeed in launching a new
“Investors see through much of
the manipulation,” they wrote. “Overstating interim returns has not been a
winning strategy for GPs on average.”
For the study, the NBER
researchers used private equity transactional and valuation history for over
200 LPs from private capital data provider Burgiss. This information, combined
with Stepstone’s SPI database of fund sequences and start dates, allowed the
authors to determine when general partners (GPs) distorted NAVs—and how these distortions
They found that exaggerated
portfolio values were associated with lower probability of raising follow-up
funds. Furthermore, conservative reporting had stronger positive effects on
fundraising than market-adjusted performance.
In particular, top-performing
GPs were shown to underreport NAVs in order to safeguard their reputation from
“GPs who are not
underperforming should have an incentive to be truthful, or even conservative,
with their unrealized investment valuations,” the authors wrote.
But whether GPs over- or
understated performance, Brown, Oleg, and Kaplan found that LPs did not take
interim performance reports at face value. Instead, investors appeared to
prefer performance signals in the form of cash distributions following
successful divestments by funds.
“Sophisticated LPs are, on
average, unlikely to misallocate capital,” they concluded.
Read the full report, “Do Private Equity Funds Manipulate
Private Equity Performance