Assessing Private Equity Performance

Abstract

Assessing the performance of private equity (PE) investments is a challenging task. It starts with the fact that the assets are privately held and illiquid. By contrast, public equity valuations are determined in a vast open market populated largely by disinterested investors acting on publicly available information. Therefore, to make an informed assessment about PE performance, investors should be aware of the areas where general partners' discretion can most influence fund performance. As PE has grown as an asset class, investors have pushed for greater disclosure and more standardization of performance metrics and benchmarks. Although this has resulted in greater standardization of the reported information, considerable opportunity remains for general partners to influence fund returns. This note summarizes the key metrics used in assessing PE performance and discusses important areas of general partners' influence on reported returns. Excerpt UVA-F-1895 Rev. Jan. 17, 2020 Assessing Private Equity Performance Assessing the performance of private equity (PE) investments is a challenging task. It starts with the fact that the assets are privately held and illiquid. What little information is available about the assets is typically controlled by the general partners (GPs) of the PE firms, who have a vested interest in making themselves look good in the eyes of their limited partners (LPs). GPs can affect the reported performance of their funds by influencing the timing of cash flows (CFs), determining net asset values, and selecting the benchmarks to be compared against. By contrast, public equity valuations are determined in a vast open market populated largely by disinterested investors acting on publicly available information. Therefore, to make an informed assessment about PE performance, investors should be aware of the areas where GP discretion can most influence fund performance. As PE has grown as an asset class, investors have pushed for greater disclosure and more standardization of performance metrics and benchmarks. Although this has resulted in greater standardization of the reported information, considerable opportunity remains for GPs to influence fund returns. This note summarizes the key metrics used in assessing PE performance and discusses important areas of GP influence on reported returns. Valuation and Performance Measurement Most individuals are familiar with investing in stocks, where a certain amount of money is invested in a stock, and then after some interval returns are measured relative to the price of the stock at purchase. The returns are the same for everyone who purchased the stock and holds it over the same interval. In PE, capital calls arrive at different points within the fund's life. The returns on the investments require GPs to monetize the assets through initial public offerings (IPOs) or sales, and prior to monetization, GPs must estimate the value of the assets. This process can create substantial variation in the reported values for the same asset. For example, in November 2002, the Wall Street Journal highlighted this issue by noting that Series A shares in Santera Systems were carried on the books of the Sequoia Fund at $ 0.46 per share, whereas the same investment was valued at $ 4.42 per share at Austin Ventures. . . .