Analyst Note
Ever since private equity firm Kohlberg Kravis Roberts tested an Amsterdam-listed fund in 2006 and competitors Fortress Investment Group and Blackstone Group went public on the New York Stock Exchange in 2007, much thought has been given to how PE firms might adapt their fund structures and sources of funding, now that the public market tap is available. About a decade after these once-controversial offerings, publicly traded PE stocks have underperformed any number of broader indices. Yet, scant analysis has been done in the way of examining returns for these publicly traded firms at the fund level, especially compared to their privately held peers.
How US PE Firms Can Keep Investing In The Next Recession
Publicly traded PE outperforms the industry over the long haul
Publicly traded PE firms outperform their privately held counterparts over the medium and long term. Limited partners at these five firms have experienced a 15-year horizon IRR of 12.38%, net of fees, compared to 10.33% in the rest of the industry. We also find similar—albeit less pronounced—outperformance on a 10-year and five-year basis. This longer-term outperformance could be attributed to several factors, explored in detail below.
These five firms may have access to better deals and more favorable terms due to their scale and international presence. The ability to deploy resources quickly and share expertise across various geographies and sectors can almost certainly be viewed as an advantage. The larger the fund, the larger the expected access to resources and deals. However, we find there is no clear difference in PE returns across various fund sizes. Even the smallest funds with commitments of less than $250 million outperform their larger counterparts on five-year and 10-year time horizons.
So, if fund size does not account for the outperformance of publicly traded PE firms over time, what else could? The comparison itself could suffer from a self-selection bias. To be certain, our returns data for the entire industry includes that of bottom-quartile funds, many of which are no longer in existence. Additionally, we would expect only the most successful PE funds to achieve sufficient scale and size to even entertain the notion of a public offering. Then, it should be obvious that these publicly traded firms have superior returns. To get around this problem, we can compare returns of publicly traded firms to those of the five largest US-based PE firms by AUM, all of which have also enjoyed outstanding success.
Larger privately-held PE firms outperform publicly-traded ones
The five largest privately held PE firms outperform the publicly traded ones in terms of IRR on every time horizon, suggesting that firms—and by extension their LPs—may be at a disadvantage by going public. Additional reporting and regulatory requirements may pose an unnecessary burden on managers’ time.
To be sure, there are differences in strategy between the firms here, and not all of them specialize in buyouts. Most notably, Oaktree and Apollo lean more on their credit and distressed strategies, while Lone Star has an emphasis on real estate, and Advent has a greater focus on Europe and Latin America. These variables will inevitably lead to differences in fund performance, if only due to macroeconomic changes and not strategy execution.
Nonetheless, the outperformance by the largest privately held PE firms is noteworthy, if only just one piece of the larger capital allocation puzzle. Other factors such as fee structure, co-investment opportunities, and exposure to certain industries and geographies should be considered. But all else being equal, LPs would be wise to consider a privately held PE firm over a public one.
Methodology
Internal rate of return (IRR):
IRR represents the rate at which a series of positive and negative cash flows are discounted so that the net present value of cash flows equals zero. The cash flows are calculated from the entire value of a fund, so IRRs are also based upon value that remains within the vehicle.
Horizon IRR:
Horizon IRR shows the IRR from a certain point in time. For example, the one-year horizon IRR figures in this report show the IRR performance for the period from 2Q 2015 to 2Q 2016, while the three-year horizon IRR shows performance for the period from 2Q 2013 to 2Q 2016.
Firm Selection:
This analysis does not include some publicly-traded firms that may be considered private equity firms. For example, Fortress Investment Group (NYSE: FIG), Och-Ziff Capital Management Group (NYS: OZM) and Ares Management (NYS: ARES) are considered asset management firms or hedge funds, not traditional PE firms. In addition, Hamilton Lane (NAS: HLNE) is primarily considered a fund-of-funds and advisory firm.
Fund Selection:
To allow for a more robust sample size, fund strategies used in this analysis are primarily buyout, distressed debt, energy, mezzanine and real estate, but also include bridge financing, co-investment, collateralized loan obligation, direct lending, fund-of-funds, infrastructure, infrastructure debt, private equity growth, and venture capital.
Vintage Year:
A fund’s vintage year is assigned by: 1) year of first investment; 2) if year of first investment is unknown, then year of final close; and 3) if firm publicly via press release or a notice on their website declares a fund to be of a vintage different than either of the first two conditions, the firm’s classification takes precedence.
Appendix I: Select vintage IRRs by Firm
Full data tables available to PitchBook subscribers
Article by PitchBook
