Estimating Private Equity Returns from Limited Partner Cash Flows

Abstract

We introduce a methodology to estimate the historical time series of returns to investment in private equity funds. The approach requires only an unbalanced panel of cash contributions and distributions accruing to limited partners and is robust to sparse data. We decompose private equity returns from 1994 to 2015 into a component due to traded factors and a time‐varying private equity premium not spanned by publicly traded factors. We find cyclicality in private equity returns that differs according to fund type and is consistent with the conjecture that capital market segmentation contributes to private equity returns.

How much can lack of marketability affect private equity fund values?

“…More generally, the paper is also related to other studies that evaluate the risk and return characteristics of private equity investments (e.g. Cochrane, 2005;Kaplan & Schoar, 2005;Ljungqvist, Richardson, & Wolfenzon, 2008;Phalippou & Gottschalg, 2009;Korteweg & Sorensen, 2010;Achleitner, Braun, & Engel, 2011;Robinson & Sensoy, 2011;Driessen, Lin, & Phalippou, 2012;Achleitner, Engel, & Reiner, 2013;Ang et al, 2013;Ewens, Jones, & Rhodes-Kropf, 2013;Higson & Stucke, 2013;Buchner & Stucke, 2014;Harris et al, 2014;Hochberg, Ljungqvist, & Vissing-Jorgensen, 2014). Recent empirical evidence shows that private equity investments slightly outperform traded stocks on a risk-adjusted basis.…”

“…Ljungqvist and Richardson (2003) document annual risk-adjusted excess returns of private equity funds of 5 to 6%. More recently, Harris et al (2014) report an annual riskadjusted excess return of 4% for buyout funds and Ang et al (2013) report risk-adjusted excess returns between 4 and 5% for the overall segment of private equity funds. These figures are quite close to the upper boundary return premia estimated here.…”

“…Interestingly, this figure corresponds pretty well to the risk-adjusted excess returns that recent studies document for private equity funds. For example, Ljungqvist & Richardson (2003), Harris, Jenkinson, & Kaplan (2014), and Ang, Chen, Goetzmann, & Phalippou (2013) report annual risk-adjusted excess returns between 4 and 6% for private equity funds. This may provide some indication that a large fraction of the documented outperformance of private equity funds is a compensation that investors require for non-marketability of the funds.…”

Are venture capital and buyout backed IPOs any different?

“…More generally, our results also contribute to the broader literature that explores the question of whether private equity investments outperform traded stock market investments. Previous research in this area includes Cochrane (2005), Korteweg and Sorensen (2010), Driessen, Lin, and Phalippou (2012), Franzoni, Nowak, and Phalippou (2012), Axelson, Sorensen, and Stromberg (2013), and Ang, Chen, Goetzmann, and Phalippou. (2013).…”

Private Equity Valuation Before and After ASC 820

“…On the other hand, many contended that venture investments are inherently too difficult to reliably fair value and argued ASC 820 would have little or no effect on these funds.To test for differences in reported net asset valuations before, during, and after the implementation of ASC 820 in 2008, we focus on the years 2002 through 2014. In most of our tests, we exclude the years 2007 and 2008 from our analysis as they overlap not only with the implementation of ASC 820 but also with the global financial crisis, which likely affected private equity valuations.18 The Preqin Private Equity Cash Flow Download is the primary data source for our sample and has been used in other academic studies including Ewen, Jones, and Rhodes-Kropf (2013) andAng, Chen, Goetzmann, and Phalippou (2018). Private equity fund NAVs, contributions, and distributions (all net of fees) as well as fund size, fund manager, and fund type are obtained by Preqin from public investors in private equity via the Freedom of Information Act.…”