NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Private Equity Performance

Each dollar invested in the average [private equity] fund returned at least 20 percent more than a dollar invested in the S&P 500. This works out to an outperformance of at least 3 percent per year.

Despite the large increase in investments in private equity funds, and the concomitant increase in academic and practitioner scrutiny of them, the historical performance of private equity (PE) remains uncertain. Up until now, there has been uneven disclosure of private equity returns, leading to questions about the quality of the data that have been available. Several commercial enterprises collect performance data, but not for all funds, and not necessarily on fund cash flows. Also, because the source of the data is often obscure, concerns about biases in the samples persist.

In Private Equity Performance: What Do We Know? (NBER Working Paper No. 17874), co-authors Robert Harris, Tim Jenkinson, and Steven Kaplan take advantage of a new research-quality cash flow dataset to better understand private equity funds and the returns they provide to investors. They find that it is highly likely that buyout funds have outperformed public markets in the 1980s, 1990s, and 2000s. Their estimates imply that each dollar invested in the average fund returned at least 20 percent more than a dollar invested in the S&P 500. This works out to an outperformance of at least 3 percent per year.

For the more recent vintage funds, the eventual performance will depend on the ultimate realization of their remaining investments, which could be higher or lower than the current valuations upon which the authors rely. All of the performance results are net of fees. The authors also acknowledge that confirmation of their PE outperformance result must await the appearance of a complete buyout fund dataset which does not currently exist.

This research also finds that Venture Capital (VC) funds outperformed public markets substantially in the 1990s, but have underperformed them in the 2000s. Vintage-year performance -- where vintage year is defined as the year when the fund begins investing -- for buyout and VC funds, both absolute and relative to public markets, decreases with the level of aggregate capital committed to the relevant asset class. This suggests that a contrarian investment strategy would have been successful in the past in these asset classes. The magnitudes of these relationships have been greater for VC funds.

Finally, although it is natural to benchmark private equity returns against public markets, investing in a portfolio of private equity funds across vintage years inevitably involves uncertainties and potential costs related to the timing of cash flows and the liquidity of holdings that differ from those in public markets. For instance, there is uncertainty regarding how much to commit to private equity funds to achieve a target portfolio allocation because of the uncertain time profile of capital calls and realizations. Consequently, there exists "commitment risk" when investing in private equity. This contrasts with investing in public markets where there is no distinction between capital committed and invested, and trading is continuous.

--Lester Picker

The Digest is not copyrighted and may be reproduced freely with appropriate attribution of source.
 
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