Research Example - ILPA White Paper
This research paper examines private investment returns and policy benchmarks, with a focus on results from the United States of America from 1995 onward. It was prepared in 2017 exclusively for members of the Institutional Limited Partners Association, an organization representing more than $2 trillion of private equity assets under management, and was authorized for broader release in June 2020. Despite having been written several years ago, the paper highlights historical investment results as well as potential pitfalls in assessing private investment performance results that continued to be at the center of the industry’s attention in 2020 and 2021. This research remains highly relevant today for the trustees, investment professionals, and beneficiaries of institutional asset owners, for investment managers and asset allocators, for academics, for government officials and regulators, and for others interested in a clearer understanding of private investments.
The paper uses a high-quality data set of private investment funds tracked by industry leader Cambridge Associates to provide convincing evidence that much of what had historically been viewed as indications of investment manager skill and/or an “illiquidity” premium based on comparisons of private equity’s results to market-cap weighted indices of mega-cap and large-cap stocks such as the S&P 500 or Russell 3000 Indices disappears when comparison are made versus indices of small-cap stocks such as the S&P 600 Index.
For example, the broad group of US venture capital, buyout, growth equity, mezzanine, distressed, and private equity funds of vintage years 1995 to 2016 raised $2.0 trillion, and generated out-performance versus the S&P 600 Index of only 1.1% annually through the end of 2016. The subgroup of $1.7 trillion of such funds from the 1998 to 2014 vintages (which omits three vintage years that include venture capital funds that were invested in time to benefit from the dot.com bubble) under-performed that same index by 0.3% annually through 2016. Both of these results were more than 3% per year worse when these private investments were measured versus this small-cap stock index than when they were compared to the S&P 500 Index, whose performance is driven by the largest companies in the market that have little in common with most private investments.
These results are robust when compared to other small-cap indices such as the Dow Jones US Small Cap and the MSCI US Small Cap 1750 Indices, though the margins of out-performance by private investments increases by over 1% when comparisons are made to the Russell 2000® Index of small-cap stocks (suggesting that private equity’s results versus the Russell 2000 may also be driven more by elements specific to that index’s construction and periodic reconstitution).
In addition to these long-term results, the study discusses a number of common pitfalls that Limited Partners should consider when analyzing performance results, especially when using IRR-based “horizon returns” to assess results over long- and short-term time periods. Long-term “horizon returns” can become “locked-in” when distributions are very high in the early years of a calculation, as they were for US venture capital for many time periods beginning in the 1990s. The result can be long-term “returns” starting from specific dates that essentially never change, despite dramatic subsequent events. This reliance upon an IRR calculation undermines the value of such “horizon returns” for comparisons to time-weighted returns or even to public-market-equivalent returns of public stocks.
The paper also recommends that Limited Partners beware of how sensitive the reported long-term “returns” of the industry can be to the results of a small number of funds. An investor who missed out on only the top 5% of US venture capital or US buyout funds would have seen their annual out-performance drop by approximately 230 basis points and 100 basis points, respectively. Both figures represent a very large proportion of a 300-basis-point annualized premium that Limited Partners often seek, suggesting that investors who lack the skills and networks to identify and access their proportional share of top-decile or top-quartile funds may find that they achieve results that differ substantially from the overall “pooled” results for the entire industry.
Research Example: The Long-Term Performance of Private Investments (up to the Onset of the COVID-19 Pandemic)
This research from 2020 provides insights into the long-term performance of private equity, venture capital, and real estate investments in North America up through the onset of the COVID-19 crisis. It demonstrates that private equity returns through the last quarterly date before markets were disrupted by the pandemic were very similar to those that investors would have achieved by instead investing in common public stock market indices. The data set includes funds formed from 1996 to 2015, with strategies focused on buyouts, growth equity, venture capital, “private equity energy”, control-oriented distressed, infrastructure, and real estate.
The paper provides details on the returns of North American private equity funds versus a range of cap-weighted and equal-weighted indices of public stocks of different sizes (including large and megacap stocks, mid-cap stocks, and small-cap stocks.
From 1996 through the end of 2019, more capital was invested in mega-cap buyouts than in other strategies, yet these funds had only beaten small cap stocks by 112 basis points. Early-stage venture capital was the performance standout, the only major strategy that had outperformed small cap stocks by more than 300 basis points.
