Investors in Private Equity Funds: Fund Preferences, Market Inefficiencies & Flexible Endowments.

Abstract

Do different types of institutional investors, e.g. pension funds, insurances or endowments etc., differ in their preferences when investing in private equity (PE) funds? To answer this question, I use a data set that covers 17,345 global investment observations in PE funds, from 1991 until 2005, to analyze returns by nine separate investor types.First, I show that there is a strong relation between LP size and GP size, even when controlling for the fund type. This correlation is significant across all LP types and I attribute this to a number of structural limitations on the side of the LP. These include, for instance, limited resources to screen proportionally more PE funds as the LP gets larger, screening by large and successful GPs for liquid LPs, as well as the need to compensate larger, but less risky GPs for limiting their risk-taking activities. Second, I find that almost 46% of investments by LPs were in buyout funds, while opportunity funds accounted for 25%. Late VC funds made up 21%, early VC funds 8%. However, there are differences by LP type: Endowments, family offices and to some degree also public pension funds and government agencies invested more often than the average investor in opportunity funds. Third, I identify that there is a high degree of home bias: An estimated 81% of investments by the average LP were on the same continent, even after controlling for the fact that PE industries globally are differentially developed and hence have different number of funds. Home bias is strongest for endowments, family offices and public pension funds; fund-of-funds were least affected. I also show that endowments more quickly and drastically adjusted their within-PE allocation: Before 2001, endowments had invested actually more often in buyout funds than the average LP, after 2001 they embraced in particular opportunity funds.Overall, the results indicate the market for fund investments is subject to significant inefficiencies that impact fund investments. These, in turn, may also help explaining why some investors are more sophisticated, or consistently more successful, than others in their PE investments.