Performance and Capital Flows in Private Equity

Transcription

1 Performance and Capital Flows in Private Equity Q Group Fall Seminar 2008 November, 2008 Antoinette Schoar, MIT and NBER

2 Overview Is private equity an asset class? True story lies beyond the aggregates Large variance and persistence in returns Idiosyncratic risk matters Implications for risk management

3 Aggregate PE returns are pro-cyclical Venture returns versus 6-year cumulative S&P Buyout and Venture Returns Relative to S&P Net Annualized IRR to Funds vs. 5 Year S&P Buyout Returns Venture Returns S&P 5 Year Source: Venture Economics

4 Multiples l are pro-cyclical l Venture multiples versus 6-year S&P Buyout and Venture Multiples Relative to Multiple on S&P for next 5 years Buyout Multiples Venture Multiples S&P 5 Years Source: Venture Economics

5 Not too surprising i Valuations are driven by exit markets IPO and M&A valuations are strongly gypro-cyclical Large capital inflows in years after high returns Funds raised in years with large capital inflows have poor subsequent performance and vice versa Young funds and funds with worse track record are especially negatively affected Established funds are better able to weather industry cycles

6 Idiosyncratic risk matters The three pillars of public equity markets Non predictability of returns Diversification Arbitrage All three are violated in Private Equity Entry limitations Ticket size Illiquidity of investments Large information asymmetries

7 Persistence of performance Bottom Medium Top Bottom Tercile 61% 22% 17% Medium Tercile 25% 45% 30% Top Tercile 27% 24% 48% Kaplan and Schoar, Journal of Finance, 2005 High likelihood that the next funds of a given partnership stays s in the same performance bracket Persistence Larger for the top quartile More persistence for top quartile funds in market downturns

8 Individual id funds returns All Funds VC Funds Buyout The average fund does not outperform the S&P IRR (0.17) (0.17) (0.19) Enormous differences in [.04, 0.20] [.03, 0.19] [.06, 0.24] performance between the top and bottom quartile (0.96) (0.96) (0.97) PME [.45, 1.17] 17] [.43, 1.13] 13] [.46, 1.14] 14] Skewness of returns Kaplan and Schoar, Journal of Finance, 2005

9 Sharp and persistent differences in LP returns over 1990s Banks Advisors Public Pensions Insurance Companies Private Pensions Endowments -5% 0% 5% 10% 15% 20% Source: Lerner, Schoar and Wang [2007]

10 But Idiosyncratic risk is lowest for high return investors Value at Risk: % of funds in lowest quartile Banks Advisors Public Pensions Insurance Companies Private Pensions Endowments Source: Lerner, Schoar and Wang [2007] 0% 5% 10% 15% 20% 25% 30% 35% 40%

11 Interpreting ti the differences Do these just reflect timing or investment mix? No robust to various controls. Are these differences due to fund access? Look at reinvestment process, where access is much less critical: Pension funds and advisors tend to invest when current returns are high. But much more dramatic difference in future returns from endowments.

12 Reinvestment and returns IRR of next fund 0 Advisors Banks Corporate Pensions Endowments Public Pensions Reinvested Did Not Invest IRR of previous fund Advisors Banks Corporate Endowments Public Pensions Pensions Reinvested Did Not Invest

13 What do endowments know that others don t? Suggests differences in ability to identify or act on inside information. Systematically obey a few simple rules that can be observed by most investors Monitor fund size and partnership growth

14 Fund Size IRR Relation IRR and Fund Size Fund size in $100 million Concave relationship between IRR and fund size Fund size is measured as capital committed at closing Regression results control for vintage year, fund category

15 Change in Fund Size Relationship of Change in IRR to Change in Fund Size Logarithm of Size Negative relationship between change in IRR and change in fund size for a given firm Fund size is measured as capital committed at closing Regression results control for vintage year effect, fund category, and firm fixed effects

16 Fund Sequence Number IRR IRR and Fund Sequence Number Sequence Number Positive relationship between IRR and fund sequence number First time funds perform especially bad Regression results control for vintage year effect, fund category and fund size

17 I Partner to Size Ratio RR IRR and Partner to Size Ratio Number of Partners to $100 million in committed capital Positive relationship between IRR and the ratio of partners to committed capital Regression results control for vintage year effect, fund category and fund size

18 Summary PE differs from other asset classes Vast heterogeneity across funds Strong persistence of returns Top quartile funds have less idiosyncratic risk than the rest of the funds Focus on relationships with top funds not ex ante asset allocation Manage investment process opportunistically Manage investment process opportunistically Bottom-up approach rather than fixed asset allocation targets Incentives for deployment of capital are detrimental to returns

19 Thank you!