PE Firms Distributed $168B To LPs In Q1; VCs Dished Out $19.7B by PitchBook
Introduction
Assessing the performance of private equity and venture capital funds is crucial and challenging in equal measure. The timeline of performance reporting is just one of the key considerations; as fund performance data trails overall investment activity statistics by a matter of months, accurately analyzing those separate datasets to produce a comprehensive overview of how fund results have shaped and will continue to shape investors’ actions can be difficult. But not overly difficult, and, furthermore, armed with not only broad dealmaking numbers but also fund performance figures, clearer and more comprehensive insights into the current private investment landscape are achievable. As an illustration, the primary storyline of the past few months has been a growing incidence of investor caution in both private and public markets, with PE fund managers dialing back activity somewhat in light of persistently high valuations and competition for quality targets. For venture investors, the existence of a true tech bubble remains uncertain, but at the very least, it’s clear that quite a few vaunted valuations garnered by late-stage startups may have been overly exuberant. Yet, looking at the most recent influx of PE and VC fund performance data, it’s clear that limited partners still have plenty of reasons to recommit to their investors. Last year saw venture fund managers worldwide return no less than $57 billion to their backers, while 1Q 2015 posted an immense $19.7 billion. Global PE cash flows were comparably mammoth, with a staggering $467.8 billion distributed back to LPs in 2014 and $168.2 billion through the end of March. The M&A boom and surging public markets that helped produce those massive sums may have shifted since, but in light of such success, PE and VC firms that have demonstrated success will likely continue to enjoy commitments on the part of their LPs, at least for some time. We hope the information contained in this report proves insightful and acts as a starting point in your efforts to benchmark the performance of PE, VC and other asset classes.
KS PME Benchmarks
An Introduction To PME Benchmarks
IRR and cash multiples have been the gold standard of benchmarking for decades, but one of their main drawbacks is that they cannot be directly compared to indices that are used in mainstream asset classes. Public-market equivalent benchmarks (PMEs) effectively address this problem, making it possible to directly compare alternative asset fund performance to the performance of indexed asset classes by using fund-level cash flows.
As there are multiple ways to calculate a PME, PitchBook has employed the Kaplan-Schoar PME method.
A white paper detailing the calculations and methodology behind the PME benchmarks can be found at pitchbook.com. PitchBook News & Analysis also contains several articles with PME benchmarks and analysis. These can be read here.
KS PME Case Study: IT
Given the current heightened valuations of many VC-backed technology companies, we decided to focus on the IT space for this report’s KS PME case study. Our KS PME benchmark formula allows us to directly compare alternative asset fund performance to the broader public market using fundlevel cash flows. Older vintage ITfocused vehicles have consistently underperformed the Russell 2000® Growth Index before shifting gears in 2008. We witnessed the most significant underperformance in 2004 vintage pools, which have underperformed by nearly 60% relative to public equivalents. Prior to the financial crisis, public equities had moved considerably higher in the years following 2004. With this steady rise in values, VC investors may have acquired many stakes in companies unable to weather the recession, and thus the fund returns at that vintage have severely underperformed their benchmark.
While 2007 saw flat performance between IT-focused VC returns and their public equivalents, 2008 vintages have experienced success, outperforming their benchmark by 22%, only second to the near-25% outperformance 2010 vintages displayed. As 2008 came directly in the midst of the last global recession, assets were acquired during distressed states, allowing for significant upside gains as the economy and markets subsequently recovered. Further, in 2010, many VCs were able to fund companies such as Palantir Technologies or Twitter (NYSE:TWTR) that were able to achieve considerable growth amid that recovery following financings at more reasonable valuations, as opposed to today’s environment.
IRR by Fund Type
Looking back to 2001, PE and debt funds have continued to display the most consistent performance in terms of median IRRs, with older vintages in both outperforming noticeably. Across relatively recent vintages, VC funds have displayed improvement, peaking at the 21.1% median IRR seen thus far by 2010 vintages. That outperformance was likely driven by early stakes acquired prior to the subsequent, rapid rise in valuations. With regard to other asset classes, one-year horizon IRRs for funds-offunds have been driven by the discrimination managers have been able to exercise in placing capital, especially with the recent volatility in public markets, and modest trepidation in dealmaking.
Quartiles & Benchmarks
With LPs chasing high returns in alternative assets more and more over the past decade, PE funds have been able to raise considerable amounts of capital. Yet as this has happened across the board, outperforming returns have become more difficult to achieve as competition for quality assets has ramped up. Moving into more recent years, this competition has contributed to rather noticeable tightening in the spread between top quartile, bottom quartile and median fund IRRs. 2001 vintages witnessed a spread of over 14.5% between top-quartile and median IRRs, along with a spread of just under 25% between top-quartile and bottom-quartile pools. Looking at the most recent data for 2012 vintages, we’ve seen these respective spreads narrow to just 9.5% and 14.2%.
Global VC IRR Quartiles By Vintage Year
IRRs for VC funds with vintages between 2009 and 2012 have been strong, peaking in 2010 with a median IRR of 21.1% and a top-quartile IRR hurdle of 36.8%. However, the landscape appears to be changing and VCs will face considerable headwinds in attempting to maintain these returns. Valuations have reached frothy levels across most asset classes, and as recent volatility in public comparables has increased the uncertainty regarding the values of many VC-backed companies, we may see a lack of liquidity that can increase hold periods and suppress future returns. Exits are down noticeably thus far in 2015, and secondary transactions are also becoming increasingly difficult to complete. Taking the above into account, recent vintages may well see their numbers slide by an appreciable amount sooner rather than later.
