The Performance of Private Equity Funds
Ludovic Phalippou and Maurizio Zollo
September 2005
Using a unique and comprehensive datat, we report that investing in the overall private equity portfolio has been a highly negative net prent value project under conrvative assumptions. We propo an estimate of performance that, in contrast to the existing literature, takes into account the time value of money when aggregating performance and, is corrected for both sample lection bias and “living dead” investments. The return of private equity funds raid between 1980 and 1996 lags by as much as 3.3% (per annum) on the S&P 500 return.
JEL: G23, G24
十大元师Keywords: Private equity funds, performance
Plea address all correspondence to:
Ludovic Phalippou,
University of Amsterdam, Faculty of Economics and Econometrics, Finance group,
11 Roerterstraat, 1018 Amsterdam, The Netherlands.
Tel: +31 20 525 4153, Email: l.phalippou “at” uva.nl尘埃落定读后感
Maurizio Zollo is affiliated to INSEAD. Financial support from the R&D Department at INSEAD and the Wharton-INSEAD Alliance are gratefully acknowledged. The authors would like to thank Jes Reyes and Thomson Venture Economics for making this project possible through generous access to their databas. We also thank Bernard Dumas, Oliver Gottschalg, Alexander Groh, Ron Kaniel, Robert Kosowski, Josh Lerner, Vinay Nair, Eric Nowak, Andrew Metrick, Dima Leshchinskii, Anna Scherbina, Antoinette Schoar, Clemens Sialm, and minar participants at INSEAD, Toulou business school, the EFMA meeting in Basle, the CEPR meeting in Gerzene, and the EFA meeting in Moscow for their constructive comments.
我要嫁给你The Performance of Private Equity Funds
Using a unique and comprehensive datat, we report that investing in the overall private equity portfolio has been a highly negative net prent value project under conrvative assumptions. We p颇怎么读
ropo an estimate of performance that, in contrast to the existing literature, takes into account the time value of money when aggregating performance and, is corrected for both sample lection bias and “living dead” investments. The return of private equity funds raid between 1980 and 1996 lags by as much as 3.3% (per annum) on the S&P 500 return.
When The Economist dubbed private equity funds as “Capitalism’s new kings”,1 it was in part commenting on the astonishing growth in the amount of money managed by the funds.2 Indeed, the capital committed to US private equity (PE) funds incread from $5 billion in 1980 to $300 billion in 2004, and in the cour of the past 25 years, over $1 trillion has pasd through the hands of private equity funds (Lerner et al., 2004). Moreover, as most investments are highly levered, the economic impact is even greater than the amounts invested suggest.3
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迎新晚会主题Despite being a major class of financial asts, estimates of the net performance of private equity funds are scarce and are the subject of this paper. Two recent exceptions — studies by Ljungqvist and Richardson (2003) and Kaplan and Schoar (2005) — both report that private equity funds outperform the S&P 500. Importantly, the focus of the two studies is not on measuring performance but rather on certain aspects of investing in private equity funds (e.g. the flow-performance relationship, performance persistence, or determinants of the speed at which capital is i
nvested). One reason why the studies do not center on the expected performance of private equity investors is the lack of a comprehensive datat. Indeed, in a univer of at least 3 400 funds, Ljungqvist and Richardson (2003) ba their analysis on 73 funds while Kaplan and Schoar (KS, 2005) examine 746 funds.
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Our study draws on an updated version of KS’s datat, comprising 983 funds. In addition, this datat is enriched by information on the performance-related characteristics of 1 391 additional funds, which enables us to correct for sample lection bias when estimating performance. Furthermore, as our focus is on performance, we make two methodological contributions that consist of a more economically appealing fund aggregation device and treatment of residual values (deletion of so-called ‘living-deads’).4 We find that the three corrections dramatically decrea performance estimates.
The first correction adjusts the original KS datat for a potential sample-lection bias (that was acknowledged by KS). Using the traditional Heckit methodology, and information about both the investment success and characteristics of the additional funds in our sample, we find that the expected performance of the additional funds is about 2% lower than the expected
1 27 November 2004, The Economist.
2 Note that real estate and entrepreneurial investments in non-public companies are sometimes called private equity. In this paper, we consider so-called private equity funds. Such funds primarily invest in buyout and venture capital.
3 For example, the largest historical buyout, of NRJ Nabisco, ud only $1 billion of equity for an acquisition worth $25 billion. More recent leveraged buyouts (LBOs), however, u less extreme leverage.
4 Residual value is the value of non-exited investments reported by funds on a quarterly basis.
performance of lected funds in terms of Internal Rate of Return (IRR) and 9% lower in terms of Profitability Index (PI).5 After correcting for this sample lection bias, the value-weighted average performance of private equity funds is found to be below that of the S&P 500 (PI is reduced from 1.05 to 0.95). The cond correction consists in computing performance bad on the aggregated cash flows across all funds, thereby giving an estimate of the return of the overall private equity portfolio. In our sample, this estimate of overall performance differs significantly from the value-weighted average performance (with capital committed as weights) ud in the literature. This change reduces PI from 1.05 (over-performance) to 0.94 (under-performance) and IRR from 16.24%
to 15.08%. Finally, we argue that the residual value reported by veral funds likely reflects ‘living-dead’ investments and should thus be written off. Indeed, we count 296 funds (out of 983) who age is above the typical age limit of funds (i.e. 10 years) and that have not shown any sign of activity (i.e. cash-flow distribution or cash-flow call) over the last four years. The $13 billion residual value reported by the 296 funds for non-exited investments is written-off. This change alone also reduces the average value-weighted PI from 1.05 to 0.94. Of particular interest, an underperformance of 0.94 is found to be statistically significant.
When we correct for the sample-lection bias, write off certain residual values (approximately half) and aggregate cash flows across funds, we obtain an IRR of 12.44% and a PI of 0.73 for the overall private equity fund portfolio. That is, private equity funds raid between 1980 and 1996 have returned only 73% (and not 105% as documented in the literature) of the invested capital in prent value terms. This corresponds to an underperformance of 3.3% per annum with respect to the S&P 500 and the three corrections above decrea the original performance estimate by a very similar amount.赋字怎么读
It is important to note that the relatively low performance estimate reported above is voluntarily optimistic. First, funds raid between 1997 and 2001 invested three times more capital as funds in
our sample and display very low preliminary performance. The funds are not included in our estimate as their performance is not definitive yet. Second, additional costs incurred by investors are not deducted from our estimated performance as we do not have access to this data. Indeed, certain investors hire funds-of-funds when investing in private equity and thus pay supplementary fees. Also, investors face transaction costs when “cashing” stock
5 Profitability Index (PI) is the prent value of the distributed cash flows divided by the prent value of the invested cash flows.
distributions made by funds. Third, we do not account for the illiquidity of the funds’ stakes for the investors. Fourth, we have implicitly assumed conrvative risk properties of private equity investments as we assign a beta of 1 to both cash inflows and cash outflows (in a CAPM framework, with the S&P 500 as a proxy for the market portfolio.) Ljungqvist and Richardson (2003), however, argue that the beta of cash outflows is clo to zero and the beta of cash inflows is higher than 1. If we u the risk-free rate to discount cash outflows and an estimated beta of 1.3 for cash inflows, the estimated performance is drastically reduced as it reaches a staggering 0.3. That is, without correcting for either sample bias, aggregation bias or living-dead, but simply assuming some fairly reasonable betas (1.3 for inflows and zero for outflows), we obtain that private equity funds have des
troyed more than two thirds of the capital allocated to them.
We also show that the underperformance of private equity funds is robust to our choice of the sample bias correction estimation, treatment of residual values and benchmark. The exact extent of the underperformance cannot be determined yet as we do not have all the necessary data and the challenging task of measuring the risk of investing in private equity funds is left to future rearch. In this paper, we propo a lower bound for this underperformance, which we estimate to be 3.3% per year. Such a finding is puzzling and prompts us to question why private equity funds have such low performance. Hypothes range from mispricing to the existence of side-benefits of investing in private equity funds. Another important issue is to asss to which extent this low performance reflects a learning cost. Interestingly, we find that the performance persistence effect documented by Kaplan and Schoar (2005) is prent in our extended sample. This means that future performance might differ from that obrved in our datat and that our findings could be partly explained by learning. Nonetheless, even if young funds are removed from the sample, we still find that private equity funds underperform. In addition, there is no significant trend in performance and if anything, the trend is negative due to the poor preliminary performance of recently raid funds.
The rest of the paper is structured as follows: Section 1 reviews the literature, Section 2 describes th
e data, Section 3 gives performance estimations, Section 4 shows some robustness checks, Section 5 discuss why our performance estimate is optimistic, Section 6 offers three explanations for the obrved underperformance of private equity funds, and Section 7 concludes.
1. Risk and Return in Private Equity Investments
A. The private equity industry (e Appendix A.I for details)
Private equity investors are principally institutional investors such as endowments and pension funds. The investors, called Limited Partners (LPs), commit a certain amount of capital to private equity funds, which are run by General Partners (GPs). GPs arch out investments and tend to specialize in either venture capital (VC) investments or buyout (BO) investments. In general, when a GP identifies an investment opportunity, it “calls” money from its LPs. When the investment is liquidated, the GP distributes the proceeds to its LPs. The timing of the cash flows is typically unknown ex ante.
B. Literature review
We can divide the literature on risk-return of private equity investments into two ts of studies. The f
irst, and most extensive t, documents the (gross-of-fees) performance of individual venture capital investments of GPs. The cond t focus on the cash-flow stream from (to) the private equity funds to (from) LPs, which includes fee payments.
The performance of individual venture capital investments made by GPs has been studied by Peng (2001), Quigley and Woodward (2003), Woodward and Hall (2003) and Cochrane (2005). The main challenge faced by the studies is that in the majority of cas, they obrve performance only when the investment was successful. Accounting for such lection bias is difficult as successful investments account for a mere quarter of the total number of obrvations.
Peng (2001), Quigley and Woodward (2003), and Woodward and Hall (2003) compute a VC index and derive the correlation between this index and a public stockmarket index. The index is built from discretely obrved valuations (new financing round, IPOs, acquisitions, or liquidation). With similar obrvations, Cochrane (2005) propos another approach. It assumes that the change in the log of the company’s valuation follows a log-CAPM and models lection bias explicitly, as it is assumed that the probability of obrving a new round follows a logistic function of firm value. Using a maximum likelihood approach, the alpha and beta of the log-CAPM that are most consistent with the obrvations are then derived.6
6 Cummings and Walz (2004) also offers an estimate of investment-level returns, focusing on how the legal environment influences performance.
