PE: Where has it been? Where is it now? Where is it going?

Transcription

1 PE: Where has it been? Where is it now? Where is it going? Steve Kaplan 1 Steven N. Kaplan

2 Overview What does PE do at the portfolio company level? Why? What does PE do at the fund level? Talk about some recent papers: PE performance with Harris and Jenkinson (Journal of Finance and Journal of Investment Management). What PE Firms Say They Do, with Gompers and Mukharlyov (JFE) What does this mean going forward? Performance? Fees? Regulation? If time, repeat for VC. 2 Steven N. Kaplan

3 What Does PE Do At The Portfolio Company Level? 3 Steven N. Kaplan

4 What Does PE Do At The Portfolio Company Level? Evidence that private equity / buyout funded companies outperform. Buyouts associated with increases in productivity. Kaplan (1989b) in the 1980s. Davis et al. (2013) from 1980s to early 2000s.» Look at large fraction of all U.S. buyouts from 1980 to 2005.» PE firms exit low productivity plants.» PE firms enter (build / buy high) productivity plants.» Net effect is: significant increase in productivity. Cohn and Towery (2014).» Similar results with tax data. Caveat - results marginally positive for public-to-privates.» Guo et al. (2008), Cohn et al. (2013). Employment growth similar / slightly lower than firms in same industry. 4 Steven N. Kaplan

5 There is a general consensus across different methodologies, measures, and time periods regarding a key stylized fact: LBOs and especially MBOs enhance performance and have a salient effect on work practices. Cumming, Siegel, Wright (2007) 5 Steven N. Kaplan

6 What Do PE Firms Do? è Suggests that PE firms are successful. Companies are more efficient. What drives the success? Kaplan and Stromberg (2009) focus on: Financial Engineering.» Better incentives and capital structure. Governance Engineering.» Better management and greater monitoring. Operational Engineering.» Capabilities to help companies operate better. 6 Steven N. Kaplan

7 What Do PE Firms Say They Do? Gompers, Kaplan and Mukharlyov (2015) look at the engineering components. Survey 79 PE firms with almost $800 B AUM. 40% to 50% of capital raised. 7 Steven N. Kaplan

8 Value Creation Identified pre-deal? Key return drivers (ranking). Growing value of business and operational improvements. Leverage and multiple arbitrage also important, but less so. 8 Steven N. Kaplan

9 Value Creation Pre-deal? Where do PE investors expect to get value when they invest? Increased revenue and improved incentives perceived as key sources of value. 9 Steven N. Kaplan

10 Who Works on the Deals? Operating partners and consultants frequently used post-deal. 10 Steven N. Kaplan

11 What about at the fund level? What is the history of commitments to PE? What does performance at the portfolio company level translate into at the fund level? 11 Steven N. Kaplan

12 $300 Commitments to U.S. Private Equity Partnerships (in $ billions) $250 $200 $ Billions $150 $100 $50 $ Source: Private Equity Analyst, Steven N. Kaplan 12 Steven N. Kaplan

13 Commitments to Private Equity Partnerships in U.S. as Fraction of Stock Market Capitalization % 1.20% 1.00% 0.80% 0.60% 0.40% 0.20% 0.00% Source: Private Equity Analyst, Steven N. Kaplan 13 Steven N. Kaplan

14 What has performance been on average? What does performance at the portfolio company level translate into at the fund level? 14 Steven N. Kaplan

15 How is performance measured? The industry focuses on two metrics Annualized IRR (net of fees) Multiple of Invested Capital (MIC) or Total Value to Paid-in-capital (TVPI).» Total Value Returned / Invested Capital» (Distributed Value + Residual Value) / (Capital calls + Fees) Each has its drawbacks Net IRR» Absolute (not relative) - does not control for the market.» Is sensitive to sequencing of investments» Does not control for leverage / beta Multiple of Invested Capital» Absolute (not relative) - does not control for the market» Does not control for leverage / beta 15 Steven N. Kaplan

16 How is performance measured? More important question, how does private equity perform relative to (or as an alternative to) public equity? A 3 rd method KS PME (Public Market Equivalent). Kaplan and Schoar (2005) introduced PME. = market-adjusted multiple. PME = Public Market Equivalent.» Σ(S&P 500 discounted value of cash outflows) t Σ (S&P 500 discounted value paid in capital) t» Compares fund to investment in S&P (including dividends).» If PME > 1, then LPs did better than S&P 500. Pros and cons:» + Does control for the market.» + Not sensitive to investment sequence.» - Still does not control for beta. 16 Steven N. Kaplan

17 Does anyone use KS PME? Calpers 17 Steven N. Kaplan

18 Who measures performance? Five commercial databases: Burgiss. Cambridge Associates (CA). Pitchbook. Preqin. State Street. Results are similar in first 4 databases. Our papers use Burgiss which is likely the most reliable. 18 Steven N. Kaplan

19 Burgiss Sourced exclusively from LPs. Include all funds and cash flows from the LPs that provide the data.» Roughly 2/3 of Burgiss clients have allowed access. LPs comprise wide array of institutions. Data come from over 200 investment programs and represent over $1 trillion in committed capital. 2/3 have PE commitments in over $100 million. Of these,» 60% are pension funds (a mix of public and corporate); and» 20%+ are endowments or foundations. Burgiss believes the PE funds in the sample represent >70% of funds ever raised. LPs use Burgiss products for their internal processes: record keeping and fund investment monitoring. 19 Steven N. Kaplan

20 What has average performance been by vintage year? U.S. Buyout IRRs by Vintage Year, Pooled Average as of June Source: Burgiss 20 Steven N. Kaplan

21 What has average performance been by vintage year? U.S. Buyout MOICs by Vintage Year, Pooled Average as of June Source: Burgiss 21 Steven N. Kaplan

22 What has performance been on average? MOIC 22 Steven N. Kaplan

23 Do Buyout Funds Outperform Public Markets? Cannot say whether Buyout PE outperforms public markets in previous slides. Need to compare individual fund cash flows to public markets. We use Burgiss individual fund cash flow data to calculate performance. 23 Steven N. Kaplan

24 Question? Have PE / Buyout funds of vintages 2006 to 2010 beaten the S&P 500? 24 Steven N. Kaplan

25 What has performance been on average? PMEs U.S. Buyout PMEs by Vintage Year, Pooled Average as of June Source: Burgiss 25 Steven N. Kaplan

26 What about beta / leverage? Also, can look at PMEs assuming 1.5 X and 2.0 X the performance of the S&P 500. Equivalent to betas of 1.5 and 2.0. Sample PMEs using beta of Average Median If buyout funds had betas much larger than 1, would expect 1997 to 1999 vintages to have PMEs (assuming beta of 1) lower than 1 because stock market declined after We do not find that. PMEs are most stable assuming betas of Steven N. Kaplan

27 Panel A: Buyout Funds What about beta / leverage? Russell indices Beta (levered S&P 500) Beta (levered Russell 2000) Beta (levered Russell 2000 value) Vintage years S&P value Average Average 2000s Average 1990s Average 1980s Sample average Sample median Steven N. Kaplan

28 Do Buyout Funds Outperform Public Markets? PMEs consistently greater than 1.0 for vintages before On the order of 1.20.» 20% outperformance over the life of the fund. Works out to 3% to 4% outperformance per year. Not sensitive to leverage. Outperform Russell 2000 and Russell 2000 value, albeit by less. Since 2006, performance roughly equal to S&P Steven N. Kaplan

29 Persistence in Performance: Are there good GPs? Do the good GPs repeat? Evidence from Harris, Jenkinson, Kaplan and Stucke (2014). Burgiss data as of December Similar results in Preqin as of December Steven N. Kaplan

30 U.S. Buyout PMEs by Vintage Year, Pooled Ave. as of June Source: Burgiss Median Top 1/4 Bottom 1/4 30 Steven N. Kaplan

31 Persistence in Performance: Top quartile performance is strong. Top 2 quartiles have PMEs > 1. Panel A : Buyout Funds A.1 Total Sample Average Average Average N IRR MOIC PME Current Fund Quartile PME % % % % A.2 Pre-2001 Funds Current Fund Quartile PME % % % % A.3 Post-2000 Funds Current Fund Quartile PME % % % % Steven N. Kaplan

32 Persistence in Performance: Are there good GPs? Historically yes but. Can you predict top quartile? Somewhat: A.1 Total Sample Average Average Average Current Fund Quartile PME Current Fund Current Fund Current Fund Previous Fund Total IRR MOIC PME Quartile PME % 27.5% 26.4% 18.7% 100.0% 13.2% % 22.4% 31.6% 19.7% 100.0% 10.3% % 26.9% 35.8% 19.4% 100.0% 10.2% % 19.6% 31.4% 29.4% 100.0% 7.8% NA, but not First Time 28.9% 26.1% 22.8% 22.2% 100.0% 13.5% First Time 29.6% 21.8% 19.7% 28.9% 100.0% 12.0% Steven N. Kaplan

33 Persistence in Performance: Are there good GPs? Historically yes but. But, it is stronger in earlier period. Stay away from bottom quartile. Current Fund Quartile A.2 Pre-2001 Funds IRR MIC PME Previous Fund Quartile PME % 25.0% 18.8% 18.8% 100.0% 17.3% % 21.7% 30.4% 17.4% 100.0% 7.2% % 25.0% 32.1% 21.4% 100.0% 11.0% % 26.1% 30.4% 26.1% 100.0% 8.2% A.3 Post-2000 Funds Previous Fund Quartile PME % 28.8% 30.5% 18.6% 100.0% 11.0% % 22.6% 32.1% 20.8% 100.0% 11.6% % 28.2% 38.5% 17.9% 100.0% 9.6% % 14.3% 32.1% 32.1% 100.0% 7.4% Steven N. Kaplan

34 Past Performance, Fundraising, Future Performance Kaplan and Schoar (2005), Kaplan and Stromberg (2009) and Robinson and Sensoy (2011) find a negative relation between capital committed to PE and future vintage year IRR and MICs. We use the Burgiss vintage year returns and the PEA capital commitments to estimate these relations. Capital committed is measured in the vintage year and the previous vintage year and is deflated by the market value of the U.S. stock market (from CRSP). 34 Steven N. Kaplan

35 Go back to the historical record Buyout Funds Dependent variable: PME IRR Multiple Capital Commitments to ** ** Total Stock Market Value [7.91] [2.92] [14.89] Constant 1.45*** 0.17*** 2.02*** [0.09] [0.03] [0.17] N R-squared Multiples and PMEs related to funds raised. 35 Steven N. Kaplan

36 Summary Buyout funds have outperformed public markets in the 1980s, 1990s, and through mid-2000s. Each dollar invested in average fund returned about 20% more than a dollar invested in the S&P 500. Works out to outperformance of > 3-5% per year. Conclusions insensitive to benchmark indices and systematic risk.» Lower, but positive using small cap / value indices. For post-2005 vintage funds, performance not so good» Roughly equal to public markets. Persistence has declined. More capital committed => worse performance. 36 Steven N. Kaplan

37 Where Is PE Going? What does all of this mean going forward? Performance? Fees? Regulation? 37 Steven N. Kaplan

38 Will funds outperform in future? Where Is PE Going? Performance PE firms have made meaningful commitments to operational engineering.» Should be able to add value to companies? 38 Steven N. Kaplan

39 Will funds outperform in future? Where Is PE Going? Performance PE firms have made meaningful commitments to operational engineering.» Should be able to add value to companies? But, many firms have done this.» Bidding against each other, does added value go to seller? 39 Steven N. Kaplan

40 Will funds outperform in future? Where Is PE Going? Performance Vintage year performance for buyout funds, both absolute and relative to public markets, decreases with aggregate capital committed.» Capital committed now well above historical average.» Understates capital committed because does not include separate accounts / direct / co-invests which also have increased markedly. 40 Steven N. Kaplan

41 Commitments to Private Equity Partnerships in U.S. as Fraction of Stock Market Capitalization % 1.20% 1.00% 0.80% 0.60% 0.40% 0.20% 0.00% Source: Private Equity Analyst, Steven N. Kaplan 41 Steven N. Kaplan

42 Fees continue to be in the news. Where Is PE Going? Fees Who do you think received more cash from Yale s endowment last year: Yale students, or the private equity fund managers hired to invest the university s money? Victor Fleischer, NYT, 8/19/2015. Pensions Join Forces to Draw Up Private Equity Fee Disclosure Guidelines WSJ, 9/5/ Steven N. Kaplan

43 Fees continue to be in the news. Where Is PE Going? Fees Creating pressure for LPs to: Scrutinize fees. Invest directly. 43 Steven N. Kaplan

44 What will happen to fees? Pressure on management fees. Volume discounts.» Separate accounts for very large LPs in larger GPs. Less pressure on better performers. Co-invest effectively reduces fees. Carry relatively stable for most funds. 8% preferred return is a real positive for PE.» Contrast with hedge funds / VC. Better performers pushing for higher carry / lower pfd. return. Much less pressure on better performers. More pressure on larger funds. Co-invest effectively reduces carry. 44 Steven N. Kaplan

45 What will happen to fees? Key issue is not the fees, but whether performance, net of fees, beats public markets. If PE beats public markets, then PE will have demand and fees will not change much. If they do not, then??? 45 Steven N. Kaplan

46 What will happen to fees? What is effect of SEC / LP focus on fees / transparency? Focus encouraged by anti-pe forces. PE funds will be more transparent. On margin, may reduce monitoring / transaction fees.» This already happening because of 0 / 100 split. 46 Steven N. Kaplan

47 Comes from Dodd-Frank. Where Is PE Going? Regulation Strange (in that PE had nothing to do with the crisis). Ironically, extra regulation favors large, existing firms. Regulations are a fixed cost.» The larger you are, the better you can amortize that fixed cost.» Larger firms can afford strong compliance. Larger firms are better at regulatory capture. Harder for new firms to start.» Compliance costs increase fixed costs of starting. 47 Steven N. Kaplan

48 What will happen to the industry overall? Who will the winners be? Industry is not going away. Duration of investments and funds is matched long-term. For best executives, private equity ownership preferable to public company ownership. Private equity a complement to public company managers versus activists. Operational engineering capabilities are real. Provides liquidity to family and corporate sellers. 48 Steven N. Kaplan

49 What will happen to the industry overall? Who will the winners be? Large, existing funds. Dodd-Frank / regulations help incumbents / existing firms.» Economies of scale in regulatory costs. Economies of scale in fundraising.» Largest investors do not want too many relationships.» Need to write large checks. Economies of scale in operational engineering. As long as performance is good enough. Key question: Does performance, net of fees, beat public markets. 49 Steven N. Kaplan

50 What will happen to the industry overall? Who will the winners be? GPs whose performance beats public markets net of fees. 50 Steven N. Kaplan

51 What About Venture Capital? 51 Steven N. Kaplan

52 Fundraising (U.S.) as % of market Commitments to U.S. VC Partnerships as Fraction of Stock Market Capitalization % 0.400% 0.350% 0.300% 0.250% 0.200% 0.150% 0.100% 0.050% 0.000% Source: Private Equity Analyst, Steven N. Kaplan 52 Steven N. Kaplan

53 Fundraising Commitments to VC as a % of overall stock market has been more stable than is commonly appreciated. Usually between 0.10% and 0.20% of total stock market. Big outliers were 1999 to to 2015 on the low side. 53 Steven N. Kaplan

54 What about performance? U.S. VC IRRs by Vintage Year, Pooled Ave. as of June Source: Burgiss 54 Steven N. Kaplan

55 What has performance been on average? MOIC U.S. VC MOICs by Vintage Year, Pooled Ave. as of June Source: Burgiss 55 Steven N. Kaplan

56 What has performance been on average? MOIC 56 Steven N. Kaplan

57 Question? Have VC funds of vintages 2006 to 2010 beaten the S&P 500? 57 Steven N. Kaplan

58 What has performance been on average? PMEs U.S. VC PMEs by Vintage Year, Pooled Ave. as of June Source: Burgiss 58 Steven N. Kaplan

59 What has performance been on average? PMEs U.S. VC PMEs by Vintage Year, Pooled Ave. as of June Source: Burgiss 59 Steven N. Kaplan

60 Overall return evidence IRRs, Multiples and PMEs vary substantially across vintage years. PMEs well above 1.0 through PMEs below to PMEs above 1 since Steven N. Kaplan

61 Persistence in Performance: Top quartile performance is strong. Only top 2 quartiles have PMEs > 1. Panel B : Venture Capital Funds B.1 Total Sample Average Average Average N IRR MOIC PME Current Fund Quartile PME % % % -9.7% B.2 Pre-2001 Funds Current Fund Quartile PME % % % % B.3 Post-2000 Funds Current Fund Quartile PME % % % % Steven N. Kaplan

62 Persistence But, can you predict who will be in the top two quartiles? 62 Steven N. Kaplan

63 Persistence in Performance: Are there good GPs? Historically yes. There is persistence in overall sample, stronger than in PE: B.1 Total Sample Average Average Average Current Fund Quartile PME Current Fund Current Fund Current Fund Previous Fund Total IRR MOIC PME Quartile PME % 16.7% 24.2% 10.6% 100.0% 33.1% % 34.2% 20.2% 16.7% 100.0% 14.6% % 29.4% 29.4% 19.3% 100.0% 10.4% % 17.3% 29.6% 38.3% 100.0% -0.3% NA, not 1st Time 22.0% 21.2% 27.3% 29.5% 100.0% 7.6% st Time 23.6% 22.1% 24.4% 29.9% 100.0% 9.7% Steven N. Kaplan

64 Persistence in Performance: Are there good GPs? Historically yes. Strong in both sub-periods. B.3 Post-2000 Funds Average Average Average Current Fund Quartile PME Current Fund Current Fund Current Fund Previous Fund Total IRR MOIC PME Quartile PME % 20.4% 25.9% 5.6% 100.0% 12.1% % 43.1% 11.8% 21.6% 100.0% 5.5% % 22.6% 41.5% 18.9% 100.0% 2.2% % 14.3% 34.3% 28.6% 100.0% -0.3% NA, not 1st Time 25.9% 19.8% 22.2% 32.1% 100.0% 1.9% st Time 22.6% 20.8% 24.5% 32.1% 100.0% 1.6% Steven N. Kaplan

65 Future Performance and Fundraising: Performance in VC significantly negatively related to fundraising. Even more so. IRR in Vintage Year =» 43% - 75 x VC inflows in current and prior year as % of stock mkt. Multiple in Vintage Year =» x VC inflows in current and prior year as % of stock mkt. PME in Vintage Year =» x VC inflows in current and prior year as % of stock mkt. On average VC inflows = 0.135% of stock market. (2 years 0.27%). 65 Steven N. Kaplan

66 Fundraising (U.S.) as % of market Commitments to U.S. VC Partnerships as Fraction of Stock Market Capitalization % 0.400% 0.350% 0.300% 0.250% 0.200% 0.150% 0.100% 0.050% 0.000% Source: Private Equity Analyst, Steven N. Kaplan 66 Steven N. Kaplan

67 Summary VC fund vintages: outperformed public markets in the 1980s, 1990s. underperformed from late 1990s to early 2000s. outperformed post For post-2005 vintage funds, performance better than PE Persistence has remained strong. More capital committed => worse performance. Today s tech boom nowhere near late 1990s boom. 67 Steven N. Kaplan

68 Steven N. Kaplan Neubauer Family Distinguished Service Professor Entrepreneurship and Finance 68 Steven N. Kaplan