Ebook Performance Measurement and Appraisal of Private Equity Investments relative to Public Equity Markets
The performance of private equity funds and their investments has recently gained wide attention from the academic community. Besides raising quantity and quality of available data, interest of investors (mainly institutional) in private equity as a vehicle for diversification and return enhancement has triggered this increase in literature on the economics of this asset class. A key topic is the risk return relationship of private equity (PE), its performance relative to public markets (PM) and the attractiveness of the investment opportunities.
Early papers mainly address the performance on the fund level. Gompers and Lerner were the first to empirically analyze the return of private equity funds relative to investments in public equity (1997). Prominent examples for research tackling the returns of private equity on the partnership level are Kaplan and Schoar (2003), Ljungqvist and Richardson (2003) and Jones and Rhodes-Kropf (2003). Cochrane (2001) examined return properties on the investment/project level. They all conclude that private equity investments do outperform public markets gross of all fees on an aggregate level. Adding a risk-adjustment, as pursued by Ljungqvist and Richardson, supported these findings. Jones and Rhodes-Kropf explicitly assess the risk premium inherent in private equity investments. Some recent studies, such as Schmidt (2003) and Gottschalg et al. (2004) question the positive alpha returns of private equity investment. In this paper we investigate whether PE investments generate a return premium over public stock markets on the project level gross of all externalities. Furthermore we are interested to assess whether this premium is adequate on a risk adjusted level.
In comparison to public equity there are two major characteristics of private equity: No liquid secondary markets and very restrictive disclosure politics of market players. Investments are in practice frequently appraised in reference to the return of a chosen benchmark investment rather than via maximizing individual utility functions. Objective and unbiased returns of public market investment often serve as reference points for performance appraisal purposes. If the relation between public market returns and the investment’s return is unclear, selecting adequate benchmarks and drawing unambiguous conclusions is difficult. In contrast to existing work we strive to explore the relation between public markets and portfolio companies rather than on a fund level. Our focus is on “pure” investment returns prior to any pooling activity by PE funds as we are interested in project returns and the quality of the PE investment universe. We strive to assess whether PE projects generate adequate return premiums over PM investments.
We use a data sample of 5,991 PE projects derived from the records of the Center of Private Equity Research (CEPRES) for our empirical analysis. Besides PE as an asset class we look at cross sectional difference from industry, geographic and stage perspectives. To answer the question whether private equity outperforms public equity we apply and compare the performance measure concepts of excess return, based on the Internal Rate of Return (IRR), and Public Market Equivalent (PME). We especially analyze the impact of the distinct reinvestment assumptions. In a second step we alter the public benchmark used, from broad to more specific indices and discuss effects for performance appraisal. Prior to introducing a risk adjustment to our performance measure we compare several risk measures and their suitability for PE investments on the project level. Based on these results we appraise performance using the established concept of the Sharpe ratio. We then introduce alternative risk adjusted performance measures that are tailored to the characteristics of private equity investments.
Contents
1 Introduction
2 Related Literature
3 Data
3.1 Data Description
3.2 Summary Statistics
4 Excess Returns
4.1 Performance measures
4.2 Summary Statistics
- 4.2.1 IRR based excess returns
4.2.2 Reinvestment Hypothesis
4.2.3 PME based excess returns
4.2.4 Specific Benchmarks
5 Risk Adjustment
5.1 Risk Measurement
5.2 Risk adjusted Performance Measurement
- 5.2.1 Sharpe Ratio
5.2.2 Modified Sharpe Ratio
5.2.3 Omega
6 Summary and Implications
Appendix A
Appendix B
Posted in :
