Past Performance Key to Future Returns (at Least in Private Equity)

Convention be damned? Preqin has found private equity consultants think the past is a guide to the future—and data suggests this may be right.

More than three quarters of private equity investment consultants believe past performance is a guide to future performance, research by Preqin has found.

The research firm questioned 40 consultants about the most important due diligence factors to assess when selecting private equity funds.

It found that 83% of consultants “stated that the best key indicator that a fund will outperform peer funds is a successful performance track record at a team level”—a statement that doesn’t sit well with the conventional investment wisdom that past performance is no guide to future performance. The group also surveyed 100 placement agents, 81% of whom agreed that a “successful performance track record at a team level” was the most important indicator of future outperformance.

Preqin’s number-crunching of performance data did find a correlation between good performance over four and six years, and strong 10-year performance—which is typically the lifespan of a private equity fund.

It found 64% of funds that ranked in the top quartile for performance over four years were also top quartile after 10. Of funds in the top quartile after six years, 79% were top-quartile after 10 years.

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The research group argued that investors could use this interim data “as a good indicator of funds’ overall performance”, which could be helpful when deciding whether to back new iterations of existing strategies.

When asked by Preqin about assessing first-time fund managers without track records, Sanjay Mistry, director of private debt at Mercer, said: “First-time funds really need to demonstrate the qualities of an established general partner in many regards in order to secure allocations. This is especially true when there are more funds than ever seeking capital.”

Mistry cited the investment history of individuals and understanding the cohesion of the team as important elements of due diligence for new offerings.

The 40 consultants quizzed by Preqin also sent out confusing messages when naming the most important factors to consider when private equity managers are fundraising.

The group said: “74% of investment consultants surveyed by Preqin state that a fund manager needs a successful performance track record at a team level to meet its fundraising target, whereas only 63% say that having a successful performance track record at a firm level is the most important trait needed.

“However, when naming warning signs that a fund manager will not successfully fundraise, 83% of investment consultants surveyed named poor performance track record of a firm as a warning sign and 80% named poor performance track record of a team.”

Stuart Taylor, head of investor products at Preqin, said the research suggested that private equity investment groups with overall poor track records “may find it difficult to attract interest from consultants and their clients”. If these firms were to bring in new teams, he added, “they will need to emphasize this to potential new investors in order to secure their capital”.

The full report can be found here.

Related Content: In-House Private Equity: Remarkably Easy? & Institutional Investors Bullish on PE Secondaries

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