Private equity investments carry a whiff of danger similar to hedge funds.
But to investors who can't afford to stay on the sidelines, such as pension funds, private equity investments are offering a welcome alternative to volatile equities and a flat bond market. And, according to recent research, we may have been seeing this alternative investment through the wrong glass.
Researchers announced today that traditional evaluation methods to quantify private equity and limited partnership performance were inaccurate. According to a joint release by PERACS Ltd, a New York- and Germany-based provider of quantitative analytics for private equity due diligence, and eFront, a global software provider that specializes in alternative investments and risk management, the data show that net-of-fee returns of large buyout funds have outperformed when compared with “equally risky public market investments.”
eFront's more than 250 clients include the giant teacher's retirement plan TIAA-Cref and the Ohio Public Employee Retirement System (OPERS). Large pension funds have sought buyout funds as an alternative to the volatility of traditional markets and in order to gain alpha.
The conclusions are part of a white paper by Professor Oliver Gottschalg of the HEC School of Management and head of research at PERACS. Gottschalg examined some three decades of cash flows from 701 mature buyout funds in the US and European Union, with an aggregate fund size of $360 billion. His team found that the top quartile of buyout funds had a higher absolute performance, 13.6% MIRR and significant Alpha, 5.10%, than public market investments with the similar risk profiles.
Gottschalg's paper, 'The Historic Performance of Private Equity – Average versus Top Quartile Returns,' contends that the market has been inaccurately measured because the traditional performance measurement of Internal Rate of Return (IRR) produced biased results, due to the longer streams of irregular cash flows inherent in private equity horizons that can span five to ten years, skewing performance results. Instead, he used a Modified IRR (MIRR) calculation, which considers, among other things, the time value of money. MIRR “resolved most of the issues with IRR,” Gottschalg writes.
The web-based eFront platform provides users, commonly portfolio managers or administrators, a dashboard view of buyout funds and analytics with which to perform due diligence on private equity deals, to analyze cash flows present and future, track deals, create benchmarks and do what-if analysis, Eric Bernstein, COO of eFront, tells Institutional Investor. “There's a tremendous trend up in private equity,” he says, noting that eFront has an inflow of one or two new clients per month. “Investors are definitely participating in private equity more than they did a year or so ago. North America is just amazing.”
