Performance of Private Equity Funds - Literature review Example

 Contents Introduction 3 In Terms of Various Authors and Analysts 4 Public Report by Jan Miczaika 4 Report by Ludovic Phalippou and Maurizio Zollo 4 Report by Ludovic Phalippou & Oliver Gottschalg 5 Ulrich Lossen 6 In Words of Geoffrey Colvin and Ram Charan 6 Lexis by Matt Krantz 6 Corp. Author: “CalPERS Investments” 7 Jesse Reyes 7 National venture Capital Association 8 Simon Targett and Florian Gimbel 8 Gary Cokins 9 Steve Kaplan and Antoinette Schoar 9 Andrew Sorkin 10 Boston Consulting Group 10 Orit Gadiesh & Hugh MacArthur 10 Conclusion 11 Works Cited 12 Introduction Private Equity funding has proved its position within some of the top investment schemes by helping some of the largest Business Empires to multiply. There is a huge list of companies that stand tall today due to some initial private placement of their equity shares; this list includes companies such as Microsoft, Apple, FedEx, and many more… Along with the spectacular growth of the capital of these companies, the private equity investment firms and their investors have also been successful in multiplying their investments in times fold. Most of the time these private equity funds have major share holding, and business control authority as their prime purpose or foundations, and are mostly only long term or medium term financers. They finance money in ways that are similar to that of banks, as a matter of fact, some of the Private financers are banks themselves. They appoint several accountants and auditing experts to check out the company’s performance and make their financing decisions based on the previous performances of the company. Although, these financers also perform fundamental and technical analysis on the company’s reports to check the future prospective of the business. The fundamental analysis is used to determine whether the fundamentals, or the basic foundations & principles of the company might stand out in the long run, and the technical analysis is conducted through various predetermined analysis techniques (quite similar to the technical analysis conducted for the Forex & Stock Markets) based on the company’s past performance to judge its future performance and growth prospects. In Terms of Various Authors and Analysts Public Report by Jan Miczaika Jan Miczaika (Research Assistant – Chair of Entrepreneurship), also like many of our other authors, compares the performance of Private equity funds with the S&P 500 index, and concludes that including the heavy fee laid by these funds, average returns (calculated during a specific 17 year period) are quite equal to that of the S&P 500 accumulated. (Miczaika) He also states that the performance of these funds is lower than S&P 500 if calculated via the equal weighted basis and higher is calculated based on the capital weighted basis(Miczaika), so the choice for these Private funds to show off their results is pretty obvious. Report by Ludovic Phalippou and Maurizio Zollo The authors state the importance of Private equity funds in the present economic conditions by using statements grabbed from The Economist such as “Capitalism’s new kings”. To prove the stability in these funds, the authors have also accumulated some very interesting data which states that the investment base of these firms has amplified from just $ 5 Billion in the year 1980 to $ 300 Billion in 2004.(Phalippou and Zollo, The Performance of Private Equity funds) The authors have used a list of 983 funds altogether to analyze their performance, and to come to the conclusions, they have used the Heckit method.(Phalippou and Zollo, The Performance of Private Equity funds) Report by Ludovic Phalippou & Oliver Gottschalg According to the study by these authors, the private equity funding firms have underperformed in contrast with the S&P 500 if their price is valued along with the outrageous fee that these people charge, but the firms over perform the index if we look at it through the gross – of - fees angle.(Phalippou and Gottschalg, The Performance of Private Equity Funds) The authors have used the NAV (Net Asset Value) technique to find out the exact return of Private equity against the S&P 500 Index, and the results were not surprising, the average profitability index was just 1.01, an extremely close performance to that of the S&P 500.(Phalippou and Gottschalg, The Performance of Private Equity Funds) Ulrich Lossen The author suggests that the similar growth pattern in Private equity funds as Ludovic Phalippou, but this author is equipped with a wider band of figures. The author has also specially pointed out that the Private equity funds had touched their peak in the year 2000, when the total size of accumulated Private equity investments had reached 260.6 Billion dollars, as compared to the 2006 figures which were a mere $ 192.3 Billion. (Lossen) Mr. Lossen of the Munich Business Research has used the regression analysis technique with five dimensions of the private equity funds: “number of portfolio companies, time, financing stages, industries, and countries” (Lossen) In Words of Geoffrey Colvin and Ram Charan Mr. Colvin in his article “Private equity, private lives” (2006) states that Private equity funds give a much better return than any national stock index, to prove his statement he has also provided us with the return figures of the S&P 500 along with the return of some prominent PE firms, which comes up to be 6.6 % for the S&P (from June 2005 till June 2006) & 22.5 % for PE firms (from June 2005 till June 2006). Although the writers also state that with the help of some “Management Strategies”, the PE firms produce over – rated results (Colvin and Charan). Lexis by Matt Krantz Matt Krantz’s article “Private equity firms spin off cash” initially sounded like the author was extremely fumed at Large Private financers; well… he used words and statements such as “They've swallowed …”, “cold - hard capitalistic mission of mining value”, and “the wave of maverick investors” (Krantz). Although, Mark criticizes the fees that these PE companies charge from their client, he even provides sources of some people calling a part of the fees structure “scandalous” (Krantz). Corp. Author: “CalPERS Investments” According to the private analysts at CalPERS Investments, the private equity funds prove to be low performers in the early years of their foundation, then slowly and gradually they begin to perform in an outstanding manner (maybe it’s because of the cumulative effect). Although the analysts have tried to analyze the performance of some of the private equity funds buy the means of the IRR method or the “Internal rate of return” technique which basically deals with cash weighing fundamentals (CalPERS Investments). Jesse Reyes Jesse Reyes clearly states why IRR technique which is a cash weighing technique is not commonly used to rate some Fund Managers’ performance, and states that the Periodic Return (a time weighing based technique is more common. Mr. Reyes also illustrates a great example of the difference between the results of both these techniques used on a sample situation. (Reyes) National venture Capital Association The National Venture capital Association based in New York wrote this article at the time when the Venture capitals were in a depression period (2002). This was the time when some VC’s almost declined by 34 % (National Venture Capital Association). The NVCA published astonishing results with little hope of any recent recovery in the position of the private equity funds. It also states that the returns were quite close to the NASDAQ Index. (National Venture Capital Association). Simon Targett and Florian Gimbel The authors came up with an astonishing new study that most of the UK’s pension companies have began investing their Billions of dollars on Private Equity as a measure to attain more growth in the funds. Although, it also mentions the declined return of venture capital funds in 2002 (time weighted method), the authors also suggest that VC’s move hand in hand with the stock indices based on a long term study. So it’s quite similar to those investments by public funds and mutual funds(Targett and Gimbel). The main focus was on the long term prospective of the private equity funds which seemed to outperform many stock indices. Gary Cokins Gary tries to illustrate the importance of the emerging star in the investment industry the “Private Equity Funds” by comparing them to various stock market indices and public funds, also states the fact can not be ignored that these funds outperform the stock indices on a longer term basis. So the methodology of Gary is also time weighted. Gary also tries to locate reasons for the sudden emergence of a bulk amount of such private investments, and he proves his point by providing the cons of public investments (amongst which he has also mentioned the boom in the IT sector in 2000). (Cokins) Steve Kaplan and Antoinette Schoar The authors have used several techniques to analyze the performance of private equity funds, although they have only used the data sets for just about 10 years but the analysis on various funds considering the duration of time was much better the expected, they used various techniques to judge the performance and rate them in comparison to various public funds and indices. Although the methodology included cash weighted techniques such as the IRR and TVPI (Total value to paid in capital), the analysis was outstanding and what astonished me the most was the fact that the analysis was conducted of LBO’s and venture capitalist firms classifiably. (Kaplan and Schoar) Andrew Sorkin The writer illustrated the details of a study conducted by the “Private Equity International” to determine which of the private equity firms was the best performer of 2007 and came to the conclusion the Carlyle Group was the winner. (Sorkin) It is to be noted that this ranking was not based on the company that contains the heaviest ratio of return on investment, but the private equity international rates its companies by the amount of investment that they have been able to accumulate during a period of 5 years. Boston Consulting Group The BCG released a press release which states that top Private equity providers have totally outperformed their other private rivals as well as the public funding firms. They have also mentioned some advantages that Private equity firms have over the public firms, such as Domain Expertise, Good Contacts & Access, Speedy decision making process. According to the BCG these factors have led to the rise in further growth opportunities for Private fund holders as compared to public fund holders (in terms of generating investment revenues and investing it) (BCG) Orit Gadiesh & Hugh MacArthur The authors make us realize the fact that financial businesses such as Private equity investments have outperformed almost all the other business scopes. They have tried to teach other businessmen some of the management techniques that PE firms use to their advantage and gain from them. They have provided some of the top disciplines followed by the PE firms that might also be helpful in calculating the risks for any business and management decisions. The authors analyze the performance of these private funds based on their past performance but on a wider scope than any of our authors here. Yes… even Mr. MacArthur has used time weighted techniques to analyze the implications, the authors have used a time period from late 1960’s and have come to the conclusion that these funds have made internal revenue of about 36 % (average per annum). (Gadiesh and MacArthur) Conclusion The research clearly states that Private funds are outperformers as compared to any other investment in their category, but only on a very long term basis, as a matter of fact, on a short term basis (particularly after the year 2000) they have been underperformers. As you may also notice that most of the authors such as Hugh MacArthur, Andrew Sorkin, Gary Cokins, … and almost all the Corporate authors have used various time weighted techniques and have not preferred to use cash weighted techniques such as IRR. Only a couple of authors Steve Kaplan and Antoinette Schoar, CalPERS Investments, and Jesse Reyes have used cash based techniques such as IRR, and even amongst them Jessereyes has criticized the IRR technique and suggests that time based models are best for such analysis. Works Cited BCG. BCG: Press releases. 21 February 2008. 29 April 2008 . CalPERS Investments. understanding Private equity performance. 25 February 2008. 29 April 2008 . Cokins, Gary. Will Private Equity Funds Turbocharge Applying Performance Management? . 5 April 2007. 29 April 2008 . Colvin, Geoffrey and Ram Charan. Private equity, private lives. 27 November 2006. 29 April 2008 . Gadiesh, Orit and Hugh MacArthur. Lessons from Private Equity Any Company Can Use . 7 March 2008. 29 April 2008 . Kaplan, Steve and Antoinette Schoar. Private Equity Performance: Returns, Persistence and Capital Flows. Michigan: MIT, 2004. Krantz, Matt. Private equity firms spin off cash. 17 March 2006. 29 April 2008 . Lossen, Ulrich. The Performance of Private Equity Funds: Does Diversification Matter? Munich: Munich Business Research, 2006. Miczaika, Jan. "Advisoria: Current Research..." 24 January 2005. Advisoria.de. 29 April 2008 . National Venture Capital Association. Private Equity Performance Continues to Reflect Tough Market Conditions. 10 June 2002. 29 April 2008 . Phalippou, Ludovic and Maurizio Zollo. "The Performance of Private Equity funds." 1 September 2005. HHS.se. 29 April 2008 . Phalippou, Ludovic and Oliver Gottschalg. The Performance of Private Equity Funds. Chicago: Social Science research Network, 2005. Reyes, Jesse. Is it possible to benchmark Private Equity performance? . London: LP Corner, 2004. Sorkin, Andrew. And the Winner Is…. 29 April 2008. 29 April 2008 . Targett, Simon and Florian Gimbel. UK pension funds target private equity. 12 May 2002. 29 April 2008 . Read More