Private Equity Portfolio Research Articles

Measuring Risk for Venture Capital and Private Equity Portfolios

For alternative assets such as venture capital, buyouts (private equity), real estate, etc., the standard regression of portfolio returns on market returns to measure risk produces risk measures that are not credible. Institutional investors, doubting such measures, instead often use either some rule of thumb, such as a stock market index plus a premium (S&P500 5, or Russell3000 3) as a benchmark, or attempt to evaluate portfolios using public market equivalents. This paper shows an alternative approach to measuring risk directly which explicitly addresses the staleness of reported values for venture capital (and other alternative assets) by including lagging market returns in the regression to capture the full relatedness of portfolio returns to market returns. Examples for venture capital and buyout portfolios show that the true risk measures are generally more than double those from naive measures lacking lagging market returns. The measurement also reveals the staleness profile of each portfolio, which can be used to calculate a mark-to-market value for the portfolio.

Bank Participation in Private Equity Funds: Risk Implication and Capital Adequacy

World markets have seen a dramatic growth in Private Equity (PE) in the last decade. Substantial portion of the new investments in PE has come from commercial banks. This study estimates the regulatory capital requirement of standard PE portfolios and evaluates various methods proposed in the Basel II regulatory guideline, in the light of the growing concern for adequate capitalisation of bank portfolios. Value-at-risk assessments are based on an ARMA-GARCH forecast model. Whereas the Basel II simple risk weight prescription for PE stands at 400% the study finds that less than 900% risk weights could be undercapitalising the portfolios.

What Public Companies Can Learn from Private Equity: Pursue the Value Journey

This article provides important guidance based on the authors’ study of top value builders from both public and private equity-owned corporations. They observe that a wide range of effective application of value-building fundamentals among public and private companies exist. A disciplined approach to value building is the prime factor of differentiation between success and failure. As a result, both public companies and private equity portfolio companies have significant room for improvement. Four major steps of the value journey provide guidance to top value builders in good times and bad. <b>TOPICS:</b>Private equity, manager selection, technical analysis, performance measurement

Performance Measurement in Private Equity

The author uses single period and multi-period regression analysis to measure the impact of public stock market returns on private equity returns. When contemporaneous and lagged market returns are included in the analysis, current valuations in private equity portfolios demonstrate considerable exposure to prior public equity returns. In addition, a large component of a private equity manger9s alpha can be explained by non-synchronous public equity returns. Finally, private equity managers exhibit the behavior of managed pricing in the valuation of their portfolio holdings. <b>TOPICS:</b>Private equity, performance measurement, statistical methods, portfolio construction

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

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.

Analyzing Real Estate Portfolio Returns

Private real estate returns cannot be explained adequately by alpha and beta alone. The fact that so many real estate managers claim positive and persistent alpha performance versus the NCREIF benchmark seems simply unbelievable to public securities investors, who know that alpha is a zero-sum game. Perhaps this outperformance is simply the result of value creation strategies such as new development or redevelopment, something that can occur only in private market investing strategies that allow the investor to take control of the asset. This third component of return—value creation—is here called gamma, making the real estate portfolio return equation equal beta + alpha + gamma. An analytic approach to such three-way performance attribution indicates that gamma is likely a much more powerful explanation of private equity portfolio outperformance than alpha could ever be.

Improving Portfolio Efficiency

A demanding market environment has left many investors seeking new solutions to address today9s investment challenges. Questions concerning issues such as portfolio efficiency and active risk are at the forefront of investors9 minds as they work through investment policy decisions. The framework here enables investors to analyze their investment policy in light of these questions, including risk budgeting and implied relative confidence levels. A typical defined-benefit portfolio illustrates the link between the active risk budget and the confidence investors place in one active strategy over another. Some important policy recommendations include introducing portable alpha and active overlay strategies, increasing allocations to hedge funds, and effectively diversifying investors9 private equity portfolio.

Managed Pricing and the Rule of Conservatism in Private Equity Portfolios

Managed Pricing and the Rule of Conservatism in Private Equity Portfolios

Managed Pricing and the Rule of Conservatism in Private Equity Portfolios

All private equity funds face the difficult issue of placing a value on the worth of their private equities. The rule of conservatism states that portfolios should be marked down quickly and up slowly, and that a triggering event, such as a new round of investment, should provide an obective, market-driven valuation point. This article determines the performance in non-market equity pricing for three classes of private equity (venture capital, leveraged buyouts, and mezzanine debt) against the U.S. Treasury bill, Nasdaq, Russell 1000, and Russell 2000 benchmark rates of return.

Separation of Ownership and Control

ABSENT fiat, the form of organization that survives in an activity is the one that delivers the product demanded by customers at the lowest price while covering costs.1 Our goal is to explain the survival of organizations characterized by separation of "ownership" and "control"-a problem that has bothered students of corporations from Adam Smith to Berle and Means and Jensen and Meckling.2 In more precise language, we are concerned with the survival of organizations in which important decision agents do not bear a substantial share of the wealth effects of their decisions. We argue that the separation of decision and risk-bearing functions observed in large corporations is common to other organizations such as large professional partnerships, financial mutuals, and nonprofits. We contend that separation of decision and risk-bearing functions survives in these organizations in part because of the benefits of specialization of