Why Endowments Outperform in Private Equity

“Stringent” governance is necessary to succeed in the opaque asset class, researchers argue.

How often do you check up on your general partners (GPs)? Research has suggested that high reporting frequency in private equity is a sign of good governance in GPs and limited partners (LPs) alike—and could lead to better overall performance.

“Reporting frequency can serve to mitigate information asymmetry and agency problems, and also serve to proxy for good corporate governance.”The more regularly a fund reports to its LPs, the less likely it is to overstate performance, according to the study. Investors are consequently armed with better information and can make better investment decisions, argued Sofia Johan and Minjie Zhang of York University’s Schulich School of Business in Ontario.

“Fund managers have significant incentives to overstate their performance to investors,” they explained. “Reporting frequency can serve to mitigate information asymmetry and agency problems, and also serve to proxy for good corporate governance.”

Frequent performance reports were a strong indicator of GP governance efforts and effective monitoring by LPs, the researchers found. LPs may require regular updates as part of “stringent” partnership agreements, Johan and Zhang said.

Endowments in particular were shown to employ the best governance practices in private equity, receiving more frequent reports than any other class of LP.

“Endowments also perform relatively better than other LPs as institutional investors in LP investments, and we believe that is a result of a strong but robust effect from the reporting behavior of private equity fund managers,” Johan and Zhang wrote.

For the study, the researchers used PitchBook’s private equity database, examining the performance and reporting behavior for 5,068 private equity funds and 492 LPs from 2000 to 2012. They found that the frequency of performance reports received by endowments was “significantly higher” than it was for other LP types—and that those reports were also less inflated than the ones fund managers gave to other LPs.

Since endowments were also the best performing LPs in the study, Johan and Zhang suggested that the good governance exhibited by these investors and their GPs could be the “secret of their success.”

Read the full paper, “Reporting Bias in Private Equity: Reporting Frequency, Endowments, and Governance.”

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