For the fourth year running an analysis of return data sourced from public-pension funds shows that past performance in private equity has something to say about future performance. All other things being equal, investors are better off backing firms whose most recent funds were top quartile for their vintage years and avoiding those whose most recent funds were bottom quartile.
Was a particular fund top quartile? The chances that a successor will also be top quartile is 38 percent, while the chances are 66 percent, or two in three, that the fund will be above median, according to this year’s analysis. The chances are 28 percent that it will be a second-quartile performer, 17 percent that it will be a third-quartile performer, and 18 percent that it will be a bottom-quartile performer.
This year’s analysis is based on a sample of 933 domestic and international buyout and turnaround funds spanning vintage years 1995 to 2011 for which we have IRRs. Of those I was able to identify clear successors for 376 funds.
The results have remained remarkably consistent year to year, despite changes to the dataset and methodology.
In prior years, for example, I included growth equity funds in my analysis but removed them this year on the basis that their risk-return characteristics are significantly different from those of buyout and turnaround firms. This year’s dataset also includes 75 vintage-2011 funds — excluded from last year’s analysis because their performance had not sufficiently ripened. The dataset also shifts to reflect the addition and loss of particular public pensions that supply the data.
And yet in both 2014 and 2015, like this year, I found that top-quartile performers repeated 38 percent of the time. In 2013 the figure was 39 percent.
Another constant of my analysis since 2013: Bottom-quartile performers tend to end up repeating as well. Managers of bottom-quartile funds end up at the bottom again on a successor fund 37 percent of the time, and below median 63 percent of the time, according to my analysis. They achieve third-quartile status 26 percent of the time, second-quartile status 21 percent of the time, and first-quartile status 16 percent of the time. Last year’s analysis found bottom-quartile funds repeating 41 percent of the time; the year before that the figure was 42 percent, and the year before that 35 percent.
Academic research has also found evidence for the persistence of private equity returns. A 2013 draft paper by four distinguished researchers, including Steven Kaplan, professor at the University of Chicago Booth School of Business, and Tim Jenkinson, professor at University of Oxford Said Business School, found persistence of performance for U.S. buyout funds pre-2000 but only mixed evidence of persistence after that.
However, limiting my analysis to just vintage 2000 or younger funds produces few differences in results. Top-quartile post-2000 vintage funds repeat 36 percent of the time, and their successors are above median nearly two-thirds of the time (65 percent). Bottom-quartile post-2000 vintage funds repeat 31 percent of the time and 60 percent of the time their successors are below median.
Can a bottom-quartile performer swing to the top quartile the next time out? Of course, and investors can give themselves a big pat on the back for finding such a firm. But they need to recognize that the odds are against them.
My analysis suggests it happens just 16 percent of the time.
Photo Credit: Image of Sherlock Holmes courtesy of ©iStock/Ostill