Industry Cycles and the Performance of Buyout Funds

Abstract

The current economic recession is the most severe downturn since the Great Depression. While virtually all sectors and industries have been affected, some industries have been affected substantially more than others. Industries behave differently not only in recessions, but also over the entire business cycle. As this article shows, industry cycles are reflected in the performance of buyout funds. Timing the cycle correctly is found to be an important performance driver. Specifically, the article finds that buyout funds are unlikely to be in the top quartile, unless they have invested in the right industry at the right time of the cycle. Although market timing is a sufficient, but not a necessary condition for outperformance, our findings have important implications for the due diligence efforts of Limited Partners. Furthermore, the results are relevant for Limited Partners with a well-diversified primary fund program, who may choose to construct a more concentrated co-investment portfolio, selecting industries they expect to have above-average upside potential. Finally, Limited Partners may employ their industry-specific expertise in valuating portfolios in the secondary market. <b>TOPICS:</b>Private equity, portfolio construction, financial crises and financial market history, developed