Against a backdrop of elevated dry powder figures and healthy fundraising for both private equity and venture capital, the sheer mass of distributions to limited partners that have prompted recommitments must be noted. No less than $416 billion was sent back to LPs by PE managers in 2015, while their venture counterparts tallied up $65.1 billion—both highs for the decade.
But what does the most recent data show? PitchBook’s latest Global PE & VC Benchmarking Report, sponsored by Donnelley Financial Solutions, reveals that venture net cash flows have turned negative for the first time since 2013, while PE GPs have still distributed at a robust rate. Now, the question for firms on both sides is how best to contend with the current cooling of the exit environment in order to realize value in the oldest post-crisis vintages.
The track record for both private equity and venture capital remains impressive. Both asset classes outperform public market equivalents across most time-frames and vintages, though PE has shown better comparative returns in the long-run, whereas VC has performed best over the last few years.
David Einhorn's Greenlight Capital funds were up 11.9% for 2021, compared to the S&P 500's 28.7% return. Since its inception in May 1996, Greenlight has returned 1,882.6% cumulatively and 12.3% net on an annualized basis. Q4 2021 hedge fund letters, conferences and more The fund was up 18.6% for the fourth quarter, with almost all Read More
Fundraising efforts have been aided by net positive cash flows to LPs—a trend that could reverse if the industry continues at its recently dampened pace of exits.
In this report, we explore various benchmarking methodologies including horizon and vintage public market comparisons, IRRs, investment multiples, and fund cash flows. We hope this report is useful in your practice. As always, feel free to contact us at [email protected] with any questions or comments.
Dylan E. Cox
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.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.
Kaplan-Schoar (KS) 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.
To find out how the PME benchmarks can be utilized to gauge performance of a specific fund or your fund portfolio, please contact us at [email protected] 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.
To find out how the PME benchmarks can be utilized to gauge performance of a specific fund or your fund portfolio, please contact us at [email protected]
When using a KS-PME, a value greater than 1.0 indicates outperformance of the public index (net of all fees). For example, the current 1.30 value for 2005 vintage PE funds means investors in a typical vehicle from that year are 30% better off having invested in PE than if they had invested in public equities over the same period.
When using a KS-PME, a value less than 1.0 indicates underperformance of the public index (net of all fees). For example, the 0.90 value for 2006 vintage VC funds means investors in a typical vehicle from that year would see only 90% of the value they would have in the public markets.
Venture performance at the three-year horizon is now only outpaced by the longest PE horizon, at 15 years. It will be interesting to track the realization of this current high performance for VC over ensuing years.
Russell Investments is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. Russell Investments is not responsible for the formatting or configuration of this material or for any inaccuracy in PitchBook Data, Inc.’s presentation thereof. For more information on Russell Investments and Russell Indices, visit www.russell.com.
KS-PME Case Study: PE & B2B
Applying a KS-PME calculation to one sector of the PE industry is useful in determining PE’s effectiveness in a given arena. Here, we compare returns for PE funds that have made at least half of their investments in B2B portfolio companies against the Russell 3000 Index. We find that B2B-focused PE funds outperform the public market equivalent on one-, three-, five-, 10-, and 15-year horizons. This outperformance is even more pronounced than the PE industry overall—indicating that PE firms do particularly well with enterpriseoriented businesses. Furthermore, each of the 11 vintages of B2B-focused funds from 2003 to 2013 has either matched or outperformed its public market equivalent, compared to PE overall which has had one year of underperformance (that was the 2010 vintage).
In many ways, enterprise-oriented usinesses are the bread and butter of PE. This would include a diverse array of professional services firms, wholesalers, equipment manufacturers, logistics providers, shipping companies, and infrastructure investments. The extensive rolodexes that PE uses for hiring and to expand to new geographies and channels, as well as the cost-cutting approach that has made the industry famous are both particularly useful for B2B companies. Such basic approaches are widely applicable, more so than the scale-oriented strategies more useful in IT, the niche sector expertise needed for energy investments, or the finicky regulatory requirements often present in both the financial services and healthcare sectors.
IRR by Fund Type
As investors decide on their capital allocations to various alternative asset classes, it’s important to keep in mind not only future trends, but also past performance. Taking a horizon IRR for each type of fund that we track, it’s evident that the performance for PE, VC, debt and fund-of-funds are nearly equivalent across the long term. On a 10-year horizon, the IRR for all four of these asset classes clocks in between 9.0% and 10.0%. However, the risk profiles for each of these industries are quite different, and the shorter-term cash flows and return dispersions vary accordingly.
Debt funds and funds-of-funds each return more consistent cash flows and thus more consistent returns across time. Horizon IRRs for these asset classes fall within a 6.1 percentage point range on one-, three-, five-, and 10-year horizons. VC funds, meanwhile, show the largest variability in returns across horizons—currently they are at a -0.9% IRR on a one-year horizon, but 14.7% over three years. This large dispersion is mostly due to a string of growing VC-backed valuations starting around 2013 that began to wane in the middle of last year.
Turning now to returns by vintage rather than horizon, VC funds outperform all other fund types for each year from 2010 to 2013. The 2011 vintage has treated investors particularly well thus far—median IRR currently sits at 17.6% for funds which debuted that year. Similar to longer time horizons, the dispersion between returns of different fund types is less pronounced for older vintages. There was no more than a 2.8 percentage point difference in returns across fund type for any vintage between 2007 and 2009.
Quartiles & Benchmarks
As the top-quartile hurdle rate has trended lower in recent vintages, the spread between the top and bottom quartiles of vintage 2013 funds is the smallest for any vintage since at least 2001. The vintage has not had enough time to flush out the best-performing funds from those with poor investments, but there are other factors at work in this situation. 2013 funds caught many of the now multi-billion-dollar unicorn investments (and other highly valued companies) later in the VC lifecycle than previous vintages—e.g. Uber, Snap, Airbnb were all worth more than $2 billion by 2013—mitigating the windfalls that go along with investing in such lucratively valued companies early on. So too has this vintage run into recent stagnation in private valuations that has effectively lowered the ceiling for IRRs on investments made at inflated early-stage rounds. Vintage 2013 funds find themselves with less than $10 billion in dry powder, about one-third the amount raised across the vintage. While that amount is large enough to cause IRR movement for the vintage, the ability for that total to be deployed and realize a full return within the normal timeline of a VC could prove difficult, stretching IRRs further.
The difference between IRRs for top and bottom quartile PE funds remains in the 10%-13% range for each vintage since 2007. The cut-off to be considered a top-quartile fund is 16% or higher for five out of the six years from 2008 to 2013, but drops significantly for prior vintages that had hold periods elongated by the financial crisis. Median IRRs for every vintage since 2004 hover in the 7%- 12% range, and we may never again see the median returns in excess of 15% produced by funds that debuted in the early 2000s. The industry has simply developed past that point and now has too many players employing similar strategies to be able to expect those kinds of returns.
The bottom-quartile (25th percentile) return for a PE fund was less than 5% for each vintage between 2004 and 2008, but has since risen to around 7% for 2011 and 2012 vintages. Bottom-quartile funds for 2013 vintages currently have negative IRRs, but these should be expected to normalize as more returns data is gathered through the lifetime of those vehicles.
Private Equity IRRs
When observing returns to the PE asset class over time, it’s imperative to keep in mind the market conditions those investments have weathered. For example, 10-year returns are approximately equal with five-year returns for any size fund, not because PE firms stop producing value after the five-year mark, but because the 10-year calculation takes into account the stretched hold periods and asset write-offs that happened as a result of the financial crisis. Furthermore, the PE exit environment, like public equities, has benefited from an almost unabated increase in prices over the last five years.
Funds under $250 million in size underperform on a one-year and three-year basis, but slightly outperform on a five-year and 10-year horizon. We attribute this to a more operational approach in smaller funds, which simultaneously depresses short-term returns and bolsters long-term ones due to the time-intensive, but ultimately fruitful nature of that approach.
Turning now to returns by geographic region, US PE funds have outperformed their European and other counterparts on a three-, five- and 10-year basis. As is the case with differences between returns for various fund sizes, however, returns by geography tend to converge over the long term.
Read the full report here.