In this month’s edition of Private Equity Spotlight, we draw upon data from the newly-launched Preqin Alternative Assets Performance Monitor, which covers:
- Buyout fund performance
- Performance by industry
- IT-focused buyout funds
- Outlook for the rest of 2017
- Fund of funds Business Keeps Dying
- Baupost Letter Points To Concern Over Risk Parity, Systematic Strategies During Crisis
- AI Hedge Fund Robots Beating Their Human Masters
Buyout Performance: The It Crowd
Using data from the newly launched 2017 Preqin Alternative Assets Performance Monitor, we evaluate buyout fund performance, using key metrics to compare the performance of sector-specific funds.
Private equity has played an increasingly important role in investor portfolios in recent years. Bolstered by the potential for strong annual returns diversified from public market performance, the industry has grown as investors that have seen strong distributions from the sector look to reinvest capital. Investor satisfaction with private equity returns has helped to drive this growth: among institutional investors surveyed by Preqin in June 2017, 89% reported that their investments had met or exceeded their expectations over the past 12 months, with this figure increasing to 92% when evaluating performance over the past three years.
Representing 57% of the $2.6tn global private equity industry, the buyout market is central to the industry and looks set to be the destination of significant investor allocations in coming years. In this article, we use data from Preqin’s newly launched 2017 Alternative Assets Performance Monitor and the Private Equity Online database to evaluate the performance of buyout funds, and reveal which industries are delivering the strongest returns.
Buyout Funds Consistently Perform
Fig. 1 shows that, with the exception of 2005 vintage venture capital funds, private equity funds have generated median net IRRs above 5% since 2005, highlighting the diversification benefits delivered by private equity investments over the course of the Global Financial Crisis (GFC). Buyout funds have delivered the most consistent returns: median net IRRs of 2005-2013 vintage funds ranged from 9.8% (2005) to 17.0% (2012), a range of just 7.2 percentage points. This is a significantly lower range than for growth (10.7pp) and venture capital (16.4pp) vehicles over the same period.
Historically, buyout funds have typically generated median net IRRs over 10% for most vintage years (Fig. 2). While there was a dip in the IRRs of buyout vehicles investing in the years prior to the GFC, the median net IRR for vintage 2005 funds is at 9.8%, while the bottom quartile IRR boundary did not fall as much as for vintage 1995-1998 funds. Since 2007, the gap between buyout vehicles delivering top- and bottom-quartile median net IRRs has generally stayed at around 10 percentage points; however, for the most recent vintages this gap has grown, despite median net IRRs remaining relatively consistent. As the gap between the best and worst performing managers widens, the importance of fund selection and due diligence increases.
Performance By Industry
Returns of buyout funds have differed considerably depending on industry focus: over one-third (36%) of information technology (IT)-focused funds have delivered net IRRs in the top quartile, the largest proportion of any specific industry focus (Fig. 3). Twenty-eight percent of telecoms, media & communications and industrials buyout funds have recorded top-quartile IRRs. Interestingly, a large proportion (28%) of funds focused on investment in the industrials sector delivered returns in the bottom quartile, indicating the dispersion of returns among industrials-focused buyout strategies.
The risk/return profile of IT-focused buyout funds is significantly different to that of other buyout fund types (Fig. 4).
The returns of IT-focused funds – which are typically strong – are much more dispersed than for funds focused on other industries. Buyout funds allocating across multiple industries account for the vast majority (80%) of buyout capital and deliver the second strongest returns, behind only funds targeting investment in IT. Given the amount of capital diversified funds represent, it is perhaps unsurprising to see these vehicles generating a wide spectrum of returns.
IT-Focused Buyout Funds Lead The Way
For most vintage years since 2000, IT-focused buyout funds outperformed the wider buyout industry (Fig. 5). Although buyout funds have generally delivered median net IRRs above 10%, technological advances and growth in IT industries across the globe have presented private equity firms with many investment opportunities as well as the potential to generate above-average returns. Over the past decade, a number of IT firms have been involved in multi-billion-dollar trade sales, leading to strong returns for private funds invested in these companies in the early stages.
Median net IRRs of IT-focused buyout funds are relatively consistent across the major markets. Asia-focused funds have recorded a higher figure (+15.3%) than funds investing in North America (+14.2%) and Europe (+13.5%), perhaps driven by the growth of China’s IT industry in recent years.
Over longer time periods, IT-focused buyout funds have generally outperformed the wider buyout industry: over the 10 years to December 2016, ITfocused funds outperformed all buyout funds by six percentage points and, while five-year horizon returns are at a similar level, IT-focused funds also outperformed over a three-year period (Fig. 6). With the IT sector providing strong returns in the buyout market, it is unsurprising to see this fund type well represented in the top performing sector-specific league table – the top three funds by net IRR are all active in the IT industry (Fig. 7).
As private equity investors continue to see strong distributions from their GPs, it is likely that these institutions will look to reinvest in the asset class. However, as the gap between the best and worst performing funds has recently widened, benchmarking funds against their peers and monitoring industry returns will be increasingly important for those seeking to manage a successful private equity portfolio.
Article by Preqin
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