For investors in buyout funds, sticking with managers who have a strong track record doesn’t always pay off.
From 2009 to 2018, only 23 percent of buyout funds in North America with a top-quartile performance at the time of fundraising remained in the top quartile in their subsequent funds, according to a recent Preqin report. The results aren’t much different than they were in the years before the global financial crisis. From 1980 to 2008, only 26 percent of the top-quartile performers kept their seats in the same quartile with their follow-on funds, according to the report.
“This leads us to believe that investors need to look beyond past performance, and that the evidence for performance persistence [among top performers] in buyouts is fairly weak,” Sam Monfared, vice president of research at Preqin, wrote in the report.
Poor performances were more likely to carry on to the next funds. Before the GFC, 42 percent of bottom-quartile funds in North America continued to be in the same quartile in their next funds. The percentage rose to 46 percent in the decade after the GFC, according to the report. About 58 percent of the bottom-quartile funds before the GFC and 56 percent after the GFC posted below-median returns in subsequent funds. The takeaway, according to Monfared, is that limited partners should steer clear of general partners who have a poor track record.
Monfared noted that his finding is somewhat contrary to traditional wisdom, which says that performance is largely constant across managers at all levels. This might result from a lack of fundraising data, or because researchers have been defining performance using different metrics, he added. In this study, Monfared measures performance of buyout funds by their internal rate of returns.
In Europe, the weak link between past performance and future results was present among funds in both the top and bottom quartiles. From 2009 to 2018, 19 percent of top-quartile funds and 21 percent of bottom-quartile funds remained in the same return category in their follow-on funds, according to the report.
The report also found a wide dispersion in performance between the top and bottom buyout funds. Globally, the average IRR from 2009 to 2018 was 37 percent for top-quartile managers and 4 percent for the bottom ones. The average net multiple, which measures returns after subtracting fees and other costs, was 2.52 for top-quartile funds and 0.97 for those at the bottom after the GFC.
“In a sense, when it comes to private equity buyouts, LPs need to focus on the future and less on the past,” Monfared concluded. “Picking the right assets and having access to the best deals ahead of competitors are the factors that buyout LPs need to pay attention to.”