If there
were any remaining questions about the returns generated by the
private equity buyout industry, a new paper by Chris Higson of
the London Business School and Rüdiger Stucke of the
University of Oxford will put them to bed. They argue, in
“The Performance of Private Equity”,
that buyout funds have, over the pat 30 years, performed
unequivocally better than public equity markets. Here’s a
blurb:
“We show that U.S. buyout funds with vintage years
from 1980 to 2008 have outperformed the S&P 500 by over
500 basis points per annum (as of June 2010).”
That’s
a lot! And why does this asset class outperform? The authors
have a nice explanation:
“Private equity firms are highly selective in their
acquisitions and seek to cherry pick targets that have
significant value creation potential. They tend to focus on
industries within their expertise. They do extensive due
diligence and arrive with a clear strategic plan that they
execute urgently, motivating senior management with a large
stick and a large carrot. They recoup invested equity as
quickly as possible and use financial leverage to amplify the
return on invested equity. Given the intensity of this process,
it would be truly surprising if private equity investors did
not generate positive gross returns.”
Clearly,
then, private equity is where it’s at! So, investors, get
out there and fill your boots up! Right? Wait, what’s that
you say? There’s a catch?
“However we find a significant downward trend in
absolute returns over all 29 vintage years. There is also a
considerable cross sectional variation in the performance of
funds. Just over 60% of funds earn a positive IRR spread
against the S&P 500, and the average fund did much better
than the median, suggesting that excess returns are mainly
driven by positive outliers.”
Let me
translate “excess returns are mainly driven by positive
outliers” for you. What the authors are saying is that top
quartile managers really deliver for their LPs...while
everybody else sort of muddles along, collecting their 200 bps
in management fees for providing public market
returns.
And
there’s the problem: Private equity funds are
fantastic...if you can get in the right ones. Good luck!
