Real Returns, Real Performance and Smarter Fund Due Diligence


July 30, 2015

It used to be easy for private equity practitioners to claim top quartile prowess without too many people being able to challenge the claim, quite astonishing for a USD 3.8 trillion slice of the financial market. As recently as two years ago, Sovereign Wealth Fund advisor Ashby Monk wrote an open letter in Institutional Investor magazine describing the problems and asking for common benchmarks and rankings to make it easier for limited partners (LP) to perform due diligence and monitor performance.


It looks like newcomers like Bison and CB Insights who are doing user-friendly things with data and new software heard the call, as did established information providers, such as Preqin, Dow Jones and Thomson Reuters who have upped their games.


Academic researchers are also doing yeoman work aggregating and analyzing data, as well as developing intuitive benchmarks and rankings to expose the private equity industry’s performance, methods and investment logic. In the past, DealMarket Digest covered performance research by the Wharton Business School, performance rankings from HEC Paris and dealflow research by Chicago’s Booth School.

This week we asked INSEAD’s Claudia Zeisberger about benchmarking and trends in global private equity performance.


DealMarket: In the latest issue of PENavigator, you state that PE has been outperforming public markets “consistently” in “most” geographies over a number of time horizons. Currently,  Europe has the strongest returns over the past ten years (see graphic below). It is quite difficult for outsiders to assess the reliability of performance claims and benchmarks. On what basis did you draw your conclusion about PE performance? (Disclosure: the author of this article had as a client a research team working at the GPEI in the past 12 months, which Claudia Zeisberger oversees.)


Claudia Zeisberger: It is not just difficult for outsiders to measure performance; it’s also difficult for insiders. Being an LP tends to be a lonely existence. It is not very easy to understand where you stand compared to other LPs. Sure, LPs have professional or peer networks but they are typically limited to their own field. Endowments don’t necessarily know how their performance compares to a Dutch insurance company or large family office.

fig1czThe dataset we use enables such comparisons. It contains real cash flows to real LPs who have placed capital with 2470 private equity fund managers. We licensed it from the data division of eFront (Pevara), a financial software-as-a-service provider. It reflects private equity returns after fees and carry without any filter or self-selection bias that is prevalent in other datasets that rely on self reporting by GPs or are based on surveys. It is broad too, covering emerging markets, venture capital, global growth and buyouts. We calculate returns conservatively using a modified IRR (MIRR) formula, which takes into account timing of cash flows and, importantly, it assumes a realistic investment rate.


It was surprising to see that global PE returns fell below double digits in 2014, 8.9% from 16.48% in 2013.


It is indeed a sub-10% return rate (based on our MIRR). The fall is attributed to GPs taking longer to divest portfolio companies in the aftermath of the financial crisis. Not surprisingly, a lower net asset value (NAV) also contributed to the lower return. Time will tell if the portfolio companies still on the books (on which the NAV is based) are duds or will deliver the kinds of exit returns seen recently.


You use regional mid and small cap indices to compare PE to public market equivalents. Is that a trend? Are more LPs and institutional investors using PME as benchmarks?


Public Market Equivalent (PME) comparison is becoming mainstream. Some examples are Kaplan Schoar PME, Long Nickels PME, Capital Dynamics PME+. Ours, which I created with Michael Prahl, makes a global comparison based on MIRR and MSCI ACWI. For Europe it is MIRR versus MSCI Europe SMID Cap Index and so on for the other geographic regions.


In private equity there are two basic ways to measure performance, the internal rate of return (IRR) or multiples (money in / money out). Comparing the private equity returns to what you would have earned if you had invested in the public market is a smart way to compare your PE returns to those in other asset clases, both at the fund level and portfolio level. Pension plans rely much more on multiples to understand performance, rather than IRR because you cannot pay pensions with IRR.  IRR is fine if you have only one fund or are analysing one deal but it isn’t good for portfolio management. It was actually developed to measure project performance.


Looking back at 2014, you wrote in PENavigator that private equity dry powder had decreased relative to the total AuM. What does that mean? I thought that GPs were having trouble doing buyouts because of all the competition from strategic buyers.


There was an estimated USD 3.8 trillion in private equity assets under management at Christmas time. Of that USD 1.1 trillion committed but not yet drawn down. Dry powder had indeed decreased slightly over 2014 but in the past six months it increased again to between 15 and 18 percentage of assets under management.



Deploying capital was particularly slow in the last quarter of 2014. Dealmaking was still being affected by overhang from pre-crisis acquisitions and effects of central banking policies on interest rates. That trend continues this year, according to the latest data from PitchBook. It shows investment activity in the US declining even further. Private equity firms and venture capital firms are saying that valuations are too high. General partners’ investment committees are reluctant to approve new investments unless the cash return can be a respectable multiple, typically between two and three times money.


Would you say the US private equity market is a bellwether or trendsetter for other regions – that is, a PE trend like the one indicated in the PitchBook report – less debt, slowing dealmaking and flattening purchasing multiples – will spread from the US, to Europe, and then Asia?


No, not at all. They all have their own dynamics and heartbeat. Of course, a global financial crisis happening again, or a major bank collapse happening again will have some fallout around the globe. But a statement on broad trends initiated by the PE markets in the US, aside from global interest trends, is next to impossible


So if the exit “super-cycle” is still ongoing– what effect is all the returning cash having on LPs?


As long as they’re getting cash back LP’s are positive towards fundraising GPs. Real estate and venture have been benefiting from limited partner liquidity. The challenge facing LPs managing a portfolio of a significant size are twofold. 1) Maintaining diversification because it is highly dependent on availability of funds in market that fit the strategy; 2) Reallocating to new funds which requires resources to develop new manager relationships and to perform due diligence on funds under consideration.

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