MIT Study: Private Equity Managers Exaggerate Performance

Research from MIT finds that buyout firms retroactively push up portfolio company valuations for a quarter when public equity markets subsequently rise.



Private equity managers tend to inflate returns when public markets do well, according to research from Massachusetts Institute of Technology’s Sloan School of Management.

A Sloan paper written last month found that buyout fund and venture capital managers, who have some discretion in calculating investment performance, are influenced by public equity gains posted after a quarter has ended. When public markets are subsequently up, private equity managers rate their own performance higher for the quarter gone by, according to the study.

“We make no claim that this behavior is intentional,” Megan Czasonis of State Street Corp.’s research group, Mark Kritzman, a senior finance lecturer at MIT, and David Turkington, a senior vice president at State Street Associates, said in the paper. “It is quite plausible that private equity managers subconsciously produce positively biased valuations merely because they are optimistic.”

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The researchers studied company-level valuation data from State Street Global Exchange’s private equity index, which represents more than half of all global private equity assets. For the first three quarters of the year, they found that private equity valuations were higher if public markets performed well immediately after the quarter ended. But when subsequent public market performance was negative, private equity valuations were not affected.


By contrast, venture capital managers did tend to downgrade their own valuations following several periods of persistent public equity losses.

“Private equity performance is not recorded immediately after the end of the quarter,” the researchers explained. “Instead, it is released over a period of one to three months.”

The reporting delay means private equity managers may be influenced by public equity market performance after the quarter is finished, according to the study. But in the fourth quarter, when private equity valuations are audited, the performance inflation disappeared.

“Private equity managers are less inclined to produce biased valuations when they are faced with audits,” the researchers said in the paper. “As such, we should expect private equity to produce, on average, higher returns relative to the public market in the first three quarters than in the fourth quarters.”