(September 28, 2011) — Returns on private equity have surpassed the public market over the long-term, a new academic paper shows.
The report says: “Despite the large increase in investments in private equity funds and the concomitant increase in academic and practitioner scrutiny, the historical performance of private equity funds remains uncertain, if not controversial. The uncertainty has been driven by the uneven disclosure of private equity returns. While several commercial databases collect performance data, they do not obtain data for all funds; they often do not disclose or even collect fund cash flow data; and they do not often disclose fund names…In fact, the median buyout fund has outperformed public markets. Average venture capital fund returns in the US, on the other hand, outperformed public equities in the 1990s, but have underperformed public equities in the 2000s.”
The paper continues: “…we evaluate two cross-sectional relationships — performance to capital flows and performance to fund size. We find that both absolute performance and performance relative to public markets are negatively related to aggregate capital commitments for both buyout and VC funds…We do not find any reliable relation between performance and fund size for buyout funds. For VC funds, we find that funds in the bottom quartile of fund size underperform. Controlling for vintage year, top size quartile funds have the best performance although it does not differ significantly from funds in the 2nd and 3rd size quartiles.”
The paper — by Robert Harris, Tim Jenkinson, and Steven N. Kaplan and titled “Private Equity Performance: What Do We Know?” — focuses on performance data as of March 2011 for US buyout and venture capital funds from Burgiss, Venture Economics, Preqin, and Cambridge Associates, considering implications for private equity performance.
“It’s surprising how good private equity has been,” Kaplan, one of the authors of the academic working paper, tells aiCIO. “For every dollar you put into private equity, at the end of the day, you have 20% more than if you left that money in public markets. Over a 5-year to 6-year period, that translates to 3% to 4% more a year in investment return.”
“There’s been a big debate on whether private equity really outperforms over the long-term, and it’s very hard to get good data on this because the people who provide the data are historically closed about it,” Kaplan, who teaches at the University of Chicago School of Business, added.
Earlier research has also been optimistic about the future of private equity. Recent research by Preqin has found that private equity fund managers looking to raise their first funds have reason to be optimistic. According to the research, more than 50% of investors have stated that they will at least consider investing in a first-time or spin-off fund, while performance data suggests that these funds have generated good returns for investors in the past.
“The private equity fundraising environment is extremely competitive, but there is evidence that despite the difficulties, emerging managers are successfully raising funds,” Preqin’s Helen Kenyon stated in a release. “While investors place a lot of importance on a fund manager’s past performance, they are keen to take advantage of highly attractive opportunities. With 36% of first-time fund managers going on to manage top quartile funds, it is perhaps not surprising that more than half of investors in private equity funds will consider backing a first-time or spin-off fund.”
A report earlier this month by SEI and Greenwich Associates showed that private equity is in demand as institutional investors, fund managers, and consultants plan to increase their allocations of the asset class or recommend increases to their clients over the next year, but they are urging greater transparency in the asset class.
The survey from SEI and Greenwich Associates, titled “The Logic of Fund Flows,” found that 26% of investors plan to increase their private equity mandates in the next year. However, investors and consultants differed on their investment objectives regarding private equity. Approximately two-thirds of investors (68%) pointed to return potential as their primary objective as opposed to 10% of consultants. Fifty percent of consultants, meanwhile, said diversification was their primary investment objective as opposed to only 18% of investors.
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