Performance of Private Equity Funds: Another Puzzle? - Risk and Return in Private Equity

Given the importance of private equity both as an investment vehicle and catalyst for economic growth, the need for a comprehensive assessment of performance and risk profile of this industry is obvious. Authors Oliver Gottschalg, Ludovic Phalippou and Associate Professor Maurizio Zollo show that the performance of venture funds is more sensitive to business cycles, while that of buyout funds is more sensitive to the state of the bond and stock markets.

by Maurizio Zollo, Oliver Gottschalg,Ludovic Phalippou

The activities of private equity (PE) funds have received increasing attention from the investor and academic community for two principal reasons. Firstly, the amount of capital committed to this asset class grew from US$2 billion in 1980 to US$134 billion in 2000. Secondly, it has been argued that fund managers play an active and important strategic role in the companies financed.

Using a comprehensive database on the performance of US and EU private equity (PE) funds, the authors find that their performance is comparable to public market performance and show how sensitive this result is to various assumptions thereby reconciling existing divergent estimates.

In Performance of Private Equity Funds: Another Puzzle? INSEAD doctoral students Oliver Gottschalg and Ludovic Phalippou and Maurizio Zollo, Associate Professor of Strategy and Management provide three key contributions. First, they test whether idiosyncratic risk is priced as argued by Jones and Rhodes-Kropf : "All else equal, the return received by the investors is increasing in the amount of realized idiosyncratic risk, even though they face competitive market conditions." Second, they assess the extent to which systematic risk affects fund performance. Third, they estimate the overall return on investment in private equity funds in the US and Europe over the last 25 years using the most comprehensive dataset to date.

The authors show that the performance of PE funds is similar to that of the public stock market and that the divergent estimates proposed in the literature can be reconciled as being due to differences in sample selection and the treatment of unrealized investments. This relatively low performance can appear puzzling a priori, but a definitive answer can be given if, and only if, the risk properties of this investment vehicle are well estimated.

To that end, the report highlights the idiosyncratic and systematic risk properties of private equity. It finds that venture fund performance is very sensitive to business cycles while buyout fund performance is sensitive to the level of corporate bond yields and, to a lesser extent, public market performance. Hence, private equity investments appear to have interesting hedging properties which may then explain their apparently low performance. In addition, they test and cannot reject the hypothesis that idiosyncratic risk is priced for this asset class.


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