Sunday, March 16, 2014

Private Equity: Persistence in Fund-Raising ... but Performance?

An above-the-fold article on the front page of a NYT business section last fall states that in the U.S. nearly 2,000 PE firms "are making pitches to state retirement systems, corporate pension funds and wealthy investors in the hope of raising nearly three-quarters of a trillion dollars for their next, new funds ... ."

A key inquiry in a decision to invest in PE is the likelihood that a PE firm's past acceptable performance persists in the firm's new fund.  Independent research, although not conclusive, indicates a low likelihood of performance persistence, not much different than what would occur randomly.

If one subscribes to PE performance persistence then deploy your or your pensioners' capital with past top performers.  And good luck.  If one doesn't subscribe to PE performance persistence then a next key inquiry is whether average net-of-fees and net-of-profit-sharing PE performance justifies the capital deployed. (Justifying here means having an expected return exceeding the cost of that capital.)

At today's prevailing fee and profit-sharing levels, independent research - again not conclusive - indicates investments in PE are not, on average, justified.  This indication is despite many super-lucrative home runs.

A point of view:  PE as an industry benefits from tailwinds of (1) a tendency of underpriced lending, (2) the tax deductibility of interest expense, (3) capital gains taxation of carried interests, and (4) PE firm compensation levels that despite having become customary do not on average adequately compensate PE investors for risks and illiquidity.  Yes, PE firms can and often do add value to their portfolio companies through better management and improved business operations.  However, the average PE firm has not been able to do so in a way that translates into adequate net returns for investors.


  1. Joe LarsenApril 14, 2014

    Private equity firms insist on and get confidential treatment of the actual specifics of these investments after these retirement systems invest in their funds. What do you suppose is the level of exposure to illiquidity for these funds?

  2. This comment has been removed by a blog administrator.