fundraising special - BVCA admin

industry
index
The real reasons
to invest in
private equity
‘The real reasons to invest in private equity’,
is a study by Oliver Gottschalg at HEC Paris.
This study uses data from 701 mature
buyout funds, based in the US and EU, with
an aggregate size of US$360bn. It uses a
modified internal rate of return (MIRR), which
makes assumptions about the financing
and re-investment rates that funds face: in
particular, cash inflows are re-invested at
the annualised rate of market return over
the remaining life of the fund, and outflows
are financed at the annualised market
return over the life of the fund so far. These
assumptions are important when calculating
MIRRs, but the authors’ sensitivity analysis
suggests that they are not critical in terms of
his broad results.
Gottschalg decomposes MIRRs in a similar
way to the BVCA-funded paper (Private
Equity Fund Level Return Attribution:
Evidence from UK Based Buyout Funds),
although he splits timing and industrymatching
into two separate categories,
giving five in total.
Using the whole sample, Gottschalg finds an
average buyout MIRR of 7.6%, compared with
an industry-matched leveraged return of
6.8%, indicating alpha of just 80bps. Although
this is statistically significant, the author
notes that it probably does not compensate
for illiquidity and unpredictability. However,
the paper also finds that top-quartile
funds deliver a higher MIRR of 13.6%, and
significantly outperform equally risky public
market investments, which return 8.5%. This
alpha estimate of 510bps is statistically (and
economically) significant. Finally, the author
then uses a modelling strategy to try to
identify future top performing funds.
endowments and the financial crisis
Private colleges have increased their allocation to alternative investments steadily over the
past 20 years, owing to good returns seen pre-2009. However, the financial crisis hit and
college endowments suffered negative returns during 2009, leading to questions about the
attractiveness of the asset class and the increasing allocations to it.
‘The Impact of Alternative Investments on Private Colleges’ Endowment Investment
Returns’ by Donald L. Basch at Simmons College finds that an increased allocation to
alternatives did lead to a decline in private colleges’ investment returns in 2009. Yet the
full impact on these returns is perhaps smaller than it is perceived to be; evidence for the
ten-year period ending 2009 shows that this emphasis on alternative investments tends to
significantly increase colleges’ cumulative investment return.
How exchange rates affect returns
The question of whether currency fluctuations have an impact on private equity returns
was examined in a recent BVCA Research Note (www.bvca.co.uk/research). Using data
from 470 PE funds invested by UK managers in the past 30 years, the study converted
the individual cash flows from these funds into sterling, dollar and euro denomination.
Benchmarking the resulting returns against each other, the study found that exchange
rates appeared to have little major impact on returns over the long term, a result borne
out by repeating the process using the Purchasing Power Parity (PPP) measure.
The note found, however, that on a three-year IRR horizon, exchange rates did play a
significant role on the returns of sterling compared to dollars and euros. Given the
fluctuations in currency seen during the recent financial crisis, and the significant
depreciation of sterling in 2008, this is perhaps unsurprising.
end of year cheer
December saw the publication of the BVCA‘s Third Annual Report on the Performance of
Portfolio Companies, produced by Ernst and Young. The report looks at a population based
on the latest annual audited reports of the 43 portfolio companies owned by PE firms that
are voluntarily subject to the Walker Guidelines on transparency and disclosure.
The report finds that the year-on-year growth rates in revenue and profits slowed from
previous years, but remained positive in the range of 3-4%, on both measures of organic
growth and bolt-ons. Further, benchmarking against both UK economy labour statistics
and the FTSE All-Share Index, PE companies outperformed on almost all metrics, with only
operating capital employed within PE portfolio companies (-3.9%) being lower than the
comparable sector-weighted FTSE numbers (5.6%).
Whilst the report found that PE-backed portfolio companies were affected by the recession
- performance in 2009 was down compared to 2008 performance metrics – the news that
they continued to outperform their publicly quoted peers was welcomed by the buyout
community.
Staying power
PE-backed buyouts are observed to have fewer early exits within 12 months and less
liquidations than their pure, non PE-backed counterparts. This is the key finding from
a recent study – ‘Staying Power of UK Buyouts’ – by Ranko Jelic at the University of
Birmingham. Using a dataset spanning 1966-2004 and covering 1,089 deals worldwide,
the study found that the total number of early exits across all buyouts has declined over
time. However, the PE-backed subsample exhibited lower levels of early exits compared
with the non PE-backed subsample. The study also found that only 2% of PE-backed
buyouts resulted in liquidations, which is lower than the average for the whole sample
and the failure rate of 3% for all UK private companies.
January 2011 BVCA Briefing 25