Private equity benchmarking is a subject of debate for fund managers not only in terms of benchmarking the investments they make, but also in terms of benchmarking themselves in the industry so that they can prove themselves and their track record to their investors.
I moderated a panel at the Superinvestor conference held in Paris on Nov. 15 titled “Benchmarking Investments in Private Equity.”
A lively debate came from three panelists. Gabriele Todesca, principal at the European Investment Fund focusing on primary fund investments in Europe; Robert Tomei, chairman and CEO of fund-of-funds Advanced Capital, responsible for the approval of every group investment for evaluation and investments in venture capital, private equity, secondary and debt strategy partnerships; and Jean-Francois Dufrasne who recently joined Thomson Reuters to head the private equity contributor relations team globally.
Figures from Thomson Reuters reveal that, in fact, the best vintages follow the crises and part of the discussion centred around how to benchmark during a down market, such as we are currently experiencing.
The main challenge from the panel, it was stressed, is putting together a high return/low risk portfolio and it seems this comes down to much more of an art than a science. That is, it seems a lower percentage of portfolio management is quantitative, the rest comes from gut feeling and having worked with fund managers previously.
Scroll down the slide show to find a summary of how our panelists benchmark their investments in a challenging market and also how they benchmark themselves.
[slide title=”How do you benchmark?”]
Gabriele Todesca stresses that industry benchmarking is a required tool, but also just one of several aspects they take into account at EIF in terms of fund selection.
EIF supplements industry benchmarking tools with internally generated data of the funds they are invested in. One of the main challenges, says Todesca is not to have benchmarking too narrow and to be aware of how returns are generated.
[slide title=”What makes a good GP?”]
Robert Tomei of Advanced Capital says you have to understand how a firm’s track record has been achieved. He also asks the question: are GPs slowing down investment pace when necessary?
He adds some GPs with exceptional track records may launch a fund which hits a rough patch and then has to reboot itself. You need to look at how a fund deals with these challenges—it is in these cases that you have to go beyond the figures.
[slide title=”How do you benchmark in a challenging market?”]
All the panelists agree you have to evolve your benchmarking to evolve with the markets.
You need to look at how investments were made in previous years and there is clearly a pattern in generating higher returns. Jean-Francois Dufrasne highlights that vintages after a crisis reveal significantly higher IRRs than those funds invested during a boom time.
Thomson Reuters figures for a pooled average of global private equity funds for 1997/1998/1999 and 2000 vintages with IRRs of 12.3%, 6.1%, 4.6% and 6.7% respectively reveal the negative effects of the Internet bubble (those funds made investments when prices were high). The years 2001, 2002, 2003 and 2004, however, followed the crisis and revealed higher IRRs of 61.1%, 19.3%, 17.5% and 11.6% respectively. The pattern continues with 2005 and 2006 vintages investing in a bull market, revealing lower IRRs of 5.2% and 1.8%. That market exploded and crashed between 2007 and 2008 which produced IRRs of 8% and 5.4% respectively. As yet, due to the J-curve effect and the current difficult environment, it’s too early to know what the most recent vintages will generate.
[slide title=”How do you benchmark yourselves?”]
An LP such as pension fund, for example has to benchmark its own investments to justify its private equity allocation in its overall allocation to make sure the private equity investments can contribute positively to overall returns.
Robert Tomei stresses it is extremely important as a fund-of-funds to benchmark yourself because you have to justify why your investors are paying your fees.
You have to deliver what you promise and stick to your core investment principles, he says. “The real benchmarking starts with yourself and staying true to the DNA of your firm.”