Private equity benchmarks and portfolio optimization (original) (raw)

Private Equity: Its Role in Portfolio Optimization

2017

Alternative investments have increasingly been used to complement a traditional portfolio of stocks and bonds. Among them, Private Equity is found to be able to provide diversification benefits and higher expected returns. This study uses the traditional mean-variance portfolio optimization process with several inputs: "equilibrium" returns for the traditional assets as a neutral starting point generated by the Black-Litterman model; and a range of expected returns of private equity fund types. We find that private equity funds in earlier stages are more suitable for investors seeking higher expected returns and with higher levels of risk appetite, while private equity in later stages are more suitable for investors with lower risk appetite, seeking for more modest levels of returns. In both cases, it is notable that the portfolio gains efficiency after the inclusion of private equity. The diversification benefits from low correlations are also observed.

Private Equity Indices Based on Secondary Market Transactions

SSRN Electronic Journal, 2018

Measuring the performance of private equity investments (buyout and venture) has historically only been possible over long horizons because the IRR on a fund is only observable following the fund's final distribution. We propose a new approach to evaluating performance using actual prices paid for limited partner shares of funds in secondary markets. We construct indices of buyout and venture capital returns using a proprietary database of secondary market prices between 2006 and 2017. These transaction-based indices exhibit significantly higher betas and volatilities, and lower alphas than NAV-based indices built from Preqin and obtained from Burgiss. There are a number of potential uses for these indices. In particular, they provide a way to track the returns of the buyout and venture capital sectors on a quarter-to-quarter basis and to value illiquid stakes in funds.

Revisiting private equity performance computation for multi-asset investors

Journal of Asset Management, 2019

Private equity has increasingly been used in portfolio for all types of investors as family offices or ultra-high net worth individuals. Financial Literature proposes different ways to compute private equity performances with results that can question the promised over-performance on public equities. The investment process in private equity funds with the system of committed capital and called capital can have a huge impact of the private equity performance in the whole portfolio and in multi-assets framework. This paper proposes an empirical study that integrates the Jcurve effect on the private equity part of a portfolio and its scaling effect with the low rate environment.

Modeling and managing portfolios including listed private equity

2012

Listed private equity (LPE) provides investors with a liquid means of considering private equity in their portfolios. This paper presents a first-order autoregressive Markov-switching model (ARMS) which is able to capture the characteristics of the asset classes bonds, stocks, and LPE, such as heavy tails and autocorrelation. Optimizing a portfolio between bonds, stocks, and LPE shows that an investor benefits from including LPE due to the high diversification effects, which also holds for a very risk-averse investor. Allocating a portfolio with the presented Markov-switching optimization can help to significantly outperform a portfolio which is optimized assuming an underlying geometric Brownian motion (GBM) -even during the financial crisis: The terminal value of a portfolio of a model investor with medium risk aversion was on average 8.7% higher over the three years 2007-2009 than the GBM portfolio.

Risk and Expected Returns of Private Equity Investments: Evidence Based on Market Prices

2009

We estimate the risk and expected returns of private equity investments based on the market prices of exchange-traded funds of funds that invest in unlisted private equity funds. Our results indicate that the market expects unlisted private equity funds to earn abnormal returns of approximately 1% per year. We also find that the market expects listed private equity funds to

Risks, Returns, and Optimal Holdings of Private Equity: A Survey of Existing Approaches

CFA Digest, 2014

We survey the academic literature that examines the risks and returns of private equity (PE) investments, optimal PE allocation, and compensation contracts for PE firms. The irregular nature and limited data of PE investments complicate the estimation and interpretation of standard risk and return measures. These complications have led to substantial disparity in performance estimates reported across studies. Moreover, studies suggest that the illiquidity and transaction costs inherent in PE investments have substantial implications for optimal holdings of these assets. While incentive fees in PE address moral hazard and information agency problems, total fees in PE investments are large and incentive fees account for a minority of total compensation.

Giants at the Gate: On the Cross-Section of Private Equity Investment Returns

SSRN Electronic Journal, 2000

We examine the determinants of private equity returns using a newly constructed database of 7,500 investments worldwide over forty years. The median investment IRR (PME) is 21% (1.3), gross of fees. One in ten investments goes bankrupt, whereas one in four has an IRR above 50%. Only one in eight investments is held for less than 2 years, but such investments have the highest returns. The scale of private equity firms is a significant driver of returns: investments held at times of a high number of simultaneous investments underperform substantially. The median IRR is 36% in the lowest scale decile and 16% in the highest. Results survive robustness tests. Diseconomies of scale are linked to firm structure: independent firms, less hierarchical firms, and those with managers of similar professional backgrounds exhibit smaller diseconomies of scale.

An Investigation of Private Equity Buyout Performance During the 2007-2009 Financial Crisis

2018

This paper investigates the net-of-fees performance of North American and European Private Equity Buyout Funds (vintages 2002 – 2007) that invested in the 2007-2009 financial crisis. To evaluate performance this study looks at both absolute return metrics such as Internal Rate of Return (IRR) and Total Value to Paid-In (TVPI) and the relative public market equivalent (PME) method conceived by Kaplan and Schoar (2005). This research builds on a 2015 Gianfrate and Loewenthal study by utilizing an updated March 31st, 2018 Preqin Private Equity Cash Flow database to gather date-specific fund-level cash flow data on 249 buyout funds as well as Bloomberg historical return data on ten public equity indices. The present study found a mean buyout IRR of 12% and a TVPI of 1.68, slightly lower than that observed in prior research. However, overall 2002-2007 buyout funds did substantially and consistently outperform their respective public market benchmarks with an average PME, calculated using...

The Private Equity Market: An Overveiw

Financial Markets, Institutions and Instruments, 1997

The private equity market is an important source of funds for start-up firms, private middle-market firms, firms in financial distress, and public firms seeking buyout financing. Over the past fifteen years it has been the fastest growing corporate finance market, by an order of magnitude over the public equity and public and private bond markets. Despite its dramatic growth and increased significance for corporate finance, the private equity market has received little attention. This study examines the economic foundations of the private equity market, analyzes its development and current role in corporate finance, and describes the market's institutional structure. It examines the reasons for the market's explosive growth over the past fifteen years and highlights the main characteristics of that growth. It provides data on returns to private equity investors and analyzes the major secular and cyclical influences on returns. It describes the important investors, intermediaries, issuers, and agents in the market and their interactions with each other. Drawing on data from trade journals, the study also estimates the market's size as of year-end 1995. 1 Some studies of particular sectors of the market, such as venture capital, and leveraged buyouts of large public companies, have been made. On venture capital, see Sahlman (1990) and special issues of Financial Management (Autumn 1994) and The Financier (May 1994). For a summary of the LBO literature, see Jensen (1994).