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A nearby vintage may be epic

History shows that the best private equity funds are born after the ends of recessions, writes David Snow.

The next great private equity fund vintage year may be taking shape right about now.

Economic predictions often do not come true, but if a growing chorus of experts are indeed right, and the US is beginning to emerge from the greatest downturn since the 1930s, then an epic vintage year for private equity fund performance may be just around the corner.

According to performance information from the State Street Private Equity Index, the best vintage years have not occurred in the midst of recessions, but in the one to three years after the recessions have technically ended. Since 1990, the best vintage years for private equity funds, as measured by State Street’s pooled average internal rate of return for all private equity funds globally, have been, in order of performance, 1991, 1993, 1994, 2003 and 2002.

David Snow

In the US, recessions are officially measured by the National Bureau of Economic Research (NBER), which defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months”. According to the NBER, the recession of the early 1990s officially lasted from July 1990 to March 1991. This means that most vintage-year 1991 private equity funds were invested overwhelmingly in the months following the end of that recession. The most up-to-date performance information from State Street shows that 1991 private equity funds on average produced a 28.44 percent IRR, net to the limited partner.

Two subsequent vintages were nearly as impressive: 1993 funds produced a 25.39 percent IRR, and 1994 funds turned in a 23.79 percent IRR.

The early 2000s recession is now widely viewed as having been brief and shallow. It officially lasted from March to November 2001, according to the NBER. The two vintage years thereafter have turned in impressive and roughly equal performances. The average 2002 private equity fund had a 19.45 percent IRR, and the average 2003 private equity fund had a 20.19 percent IRR.

The funds of the early 1990s enjoyed an advantage that early-2000 funds did not: they operated in an economy that grew for a full 120 months before hitting a recession in 2001. The funds of the early 2000s, while enjoying copious amounts of debt, only had 73 months of economic growth before the next recession hit in late 2007.

Historical data on vintage-year performance indicates that LPs need not worry about missing the chance to invest in the midst of a recession. The years after the recession are over tend to be even stronger – especially if the good times last.

The current recession (if indeed it is still technically a recession) caught even the most grizzled investment veterans off guard. Its path to recovery may therefore not go as market participants predict or wish. An oft-overlooked fact of the Great Depression is that it ended in 1933 before tumbling back into recession in 1937. A similar scenario would prove especially destructive for otherwise hopeful 2009 and 2010 vintage-year investors.