Quants have affirmed what most allocators hold to be true:
Investing in private equity funds is a skill unto itself.
Limited partners’ (LPs) returns tend to persist
beyond what random distribution would indicate, an analysis of
12,043 investments by 630 LPs has found. One standard deviation
in allocator skill translated to roughly 3 percentage points in
added annual internal rate of return (IRR), according to the working paper, published in August by the
Charles A. Dice Center for Research in Financial Economics at
Ohio State University’s Fisher College of
The four authors, who derived their 15-year sample
(1991–2006) from data providers S&P Capital IQ and
Thomson Economics’ VentureXpert, found it
consistent with research firm Preqin’s
industrywide performance figures.
Using a model designed to measure general partner (GP)
skill, the researchers controlled for investments’
vintage year, strategy (buyout versus venture capital), and
other factors to isolate LPs’ fund and manager
Dartmouth College’s endowment added more value
through skill than any other institution analyzed, followed by
the William and Flora Hewlett Foundation. The Louisiana State
Employees’ Retirement System, perhaps
surprisingly, came in first among pension funds, handily
topping the Canadian and Californian giants.
The greatest selection-based losses all came from U.S.
public funds: the Teachers’ Retirement System of
the State of Illinois, the New Hampshire Retirement System, and
the Ohio Police and Fire Pension Fund. The New
Jersey–based Meadows Foundation and the
U.K.’s Wellcome Trust placed last among
"These estimates are relatively noisy," the authors warned,
noting an average 2.5 percent standard of error. "It does
appear, however, that the LPs we identify as being in the top
[skill] group do have noticeably better performance than those
in the bottom group."
The findings reflected investment performance for
funds’ lifespan; they didn’t account
for performance spreads on stakes bought or sold midway.
Likewise, portfolio holdings were only as complete as reported
in the two databases.
Individual LPs’ rankings ought to be taken with
caution, but what’s clear is that "the ability of
LPs to pick GPs is not random, and better LPs outperform less
talented LPs," the researchers wrote.
Therefore, they concluded, "it makes sense for institutional
investors to bid to acquire the best investment officers, and
that high-quality investment officers can more than earn their
relatively high salaries."
Even CIOs who would quibble with their skill score probably
Leanna Orr is Global Content Director of Investor
Intelligence Network (IIN), Institutional
Investor’s private community for asset