In the world of private equity, every variable in an institutional investor’s programme – geographic focus, partner selection, size of commitment – can have a substantial impact on returns.

When big institutions benchmark their returns against their peers and find they are outperforming, is it skilful manager selection, supreme relationships or plain blind luck? Until now it has been tricky to quantify some of these metrics.

Professor Oliver Gottschalg, founder and head of research at fund analysis firm PERACS, has devised a solution. His Limited Partner Capability Indicator compares the buyout returns of 11 US public pensions – those with the best risk-adjusted returns, according to his analysis – to calculate how variables such as regional exposure, the ability to select the best managers and the ability to secure a desired commitment size affect performance.

Had each pension in the LPCI invested in every buyout fund launched between 2004 and 2014, they would have generated a 1.56x return. In reality, all but one of the LPs outperformed this benchmark. Here are the factors which had the greatest impact on performance:

Region choice effect 

For example, if an LP had only invested in Asia from 2010 onwards, they may have missed out on some bumper performance earlier in the decade another LP was able to tap into. Likewise, one LP could have a heavier weighting to one region over another and would therefore benefit from any outperformance in those markets. Regional exposure played an important role in determining the success of a portfolio. The LPCI took into account the relative geographic composition of each of the 11 portfolios and how 2004-14-vintage buyout funds performed in these regions.

The research found that Los Angeles Fire and Police Pension System received a 0.06x boost to its overall total-value-to-paid-in from region choices – more than any other LP.  In other words, this pension fund had the smartest geographic allocation over the time period, which drove programme performance.

GP selection effect

The ability to identify top-performing GPs in a chosen segment also plays a role. These LPs would have been presented with a host of potential vehicles that fell within their strategy and regional allocation, but some of these funds would perform better than others.

The LPCI analysed the performance of every buyout fund within an investor’s opportunity set, ie, the funds they could have invested in given its region choice and vintage weighting, and compared this with the performance of the ones it did commit to, assuming a commitment of the same percentage of fund size to each fund. If the latter selection outperformed the average performance of its opportunity set, the LP’s investment professionals demonstrated a greater ability to identify the best GPs.

Minnesota State Board of Investment demonstrated the best ability to select the right GP, with these decisions contributing 0.09x to its portfolio performance. State Teachers’ Retirement System of Ohio committed to funds that underperformed the opportunities available to its staff, knocking 0.05x off its potential returns.

Access/conviction effect

GP selection is meaningless if the LP is unable to commit to its preferred funds. The third metric considered by LPCI is the investor’s ability to secure its desired commitment size – often seen as an indicator of its relationship with GPs – and its conviction to write larger than average cheques to its chosen partners.

“If they have relationships where they let you in with $2 or $3 million, not $100 million, you know who they [the best performing funds] are but they won’t let you in at the level you want,” Gottschalg says. “If you can identify and they let you in with the corresponding commitment, they give you a high access conviction.”

Los Angeles Fire and Police Pension System received a 0.14x boost to its returns as a result of its ability to gain its desired commitment – more than any other LP. This is compared with Public Employee Retirement System of Idaho, whose returns would have been 0.1x higher had it been able to deploy substantial capital to its chosen funds.