Is Private Equity Delivering? by Pantheon
A study published today by global private equity and real assets investor, Pantheon, finds that private equity has outperformed both passive and active equities on a historical basis, net of management fees and carry. “Is Private Equity Delivering?” set out to quantify historical private equity returns from 1990 to 2006 relative to public equity benchmarks, and established significant outperformance against both the passive public equity benchmark as well as an active public equity universe.
The approach taken by the study’s authors, Dr. Andres Reibel, a member of Pantheon’s Research Team, and Nik Morandi, Global Head of Portfolio Strategy and Research, first compared the performance of U.S. buyout funds to the S&P 500 index, as a proxy for passive equities, based on a historical dataset. Building on the work of previous studies, such as Harris, Jenkinson and Kaplan, Pantheon’s team focused on how top quartile buyout funds perform. Annualized, the study’s historical dataset suggests that top quartile U.S. private equity buyouts generated an annual net outperformance of approximately 4.9% compared to the S&P 500*.
The second part of the study considered active public equity performance. Here Pantheon compared U.S. private equity performance to that of actively-managed U.S. mutual funds, using Preqin and Bloomberg data respectively. We found net outperformance of upper quartile U.S. buyout funds relative to the U.S. mutual fund peer group of approximately 3.7% annually*. The study found that excess performance was achieved even outside of the top quartile. Average buyout funds4 generated 1.0% of outperformance annually against the passive benchmark and 0.4% against the U.S. mutual fund dataset, also on a net basis*.
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Nik Morandi observed: “Within the context of our study, an allocation to private equity when considered against both passive and actively-managed public equities makes sense. The outperformance seen in the study is both consistent and clearly identifiable, especially from top performing private equity managers.”
Is Private Equity Delivering? – Introduction
Perhaps the most common performance-related question that private equity investors ask is whether their private equity portfolio is generating a return that is above what they would otherwise be able to generate through investing in public (listed) equities. As most readers may already be aware, private equity performance is traditionally benchmarked against broad, passive public equity indices such as the S&P 500. As we have previously argued elsewhere, private equity assets share many features with publicly-listed equities, and can behave similarly over the long run. Given these shared features, the use of public equity indices for benchmarking purposes is an accepted standard within the private equity industry, notwithstanding a number of differences between the two asset classes.
One central difference between private and public equity investing is that, unlike the majority of public equity investment managers, private equity fund managers typically acquire controlling stakes in firms with the intention of effecting beneficial change, be that on a managerial, operational, or financial level. Therefore, the investment role undertaken by a typical private equity fund manager can differ quite substantially from the role undertaken by a typical public equity fund manager.
However, similarities between private equity fund managers and public equity fund managers do exist: one of these is the active portfolio management component. Private equity fund managers aim to seek out the most attractive individual company investments when constructing their portfolios and are not constrained by the requirement to consider any specific reference benchmark or index. Similarly, some public equity fund managers will deviate substantially from the public equity benchmark against which their performance will generally be measured. Rather than passively tracking a benchmark index, they will seek to add value (and thereby aim to generate outperformance) by actively identifying stocks that have the potential to perform more strongly than public equity markets overall. In reality, few public equity fund managers regard themselves as purely passive index trackers, but there is a spectrum based on the level of divergence from the relevant public market index that an individual manager is prepared to tolerate. The more a public equity fund manager does this, and thereby deviates from an index when constructing its overall portfolio, the more it can be thought of as an “active” equity fund manager.
Once we consider this distinction, another performance comparison approach for private equity presents itself. Rather than just benchmarking private equity performance against a suitable passive public equity benchmark (such as the S&P 500, FTSE All-Share, or MSCI All Country World Index, as appropriate) we can consider comparing private equity’s performance against that of active public equity funds. A performance comparison exercise that utilizes broad-based benchmarks, such as the S&P 500, seems valid to the extent a private equity investor regards a passive – or index-based – public equity strategy as its closest alternative investment choice. However, to the extent that an actively-managed public equity portfolio is regarded as a reasonable (or indeed a preferred) alternative to a private equity investment program, then a benchmark based on a cohort of active public equity managers (e.g. mutual funds) is perhaps more suitable.
See full PDF below.