Quantitative Private Equity Fund Due Diligence: Possible Selection Criteria and their Efficiency

Abstract

The accurate selection of private equity fund managers is as crucial for the performance of one's private equity portfolio as it is challenging. Data paucity, few benchmarking possibilities and the long time lag between commitment decisions and performance outcomes makes private equity fund due diligence still look more like an art than a science. This article presents some of the possibilities to integrate quantitative methods into the due diligence process. Drawing on a comprehensive analysis of 615 historical due diligence situations, we document the relationship between GP characteristics (measured at the time a new fund is raised) and the subsequent performance of that focal fund. We are looking at various measures of past GP performance, but also at other aspects, such as dealflow or experience and assess to what extent these are statistically significant determinants of focal fund performance. In a second step, we assess the selection efficiency of some of these criteria, i.e. the degree to which their use for fund selection purposes would have historically led to above-average portfolio performance. Our results show the limited efficiency of 'generic' selection rules, such as the 'top quartile' rule, especially compared to more comprehensive fund rating approaches that simultaneously consider multiple complementary selection criteria.