Can you name the most successful private equity fund ever? There are probably a number of GPs reading this who would say ‘yes’ and point to a fund in their own firm’s history which, by at least one metric, is a contender.
But metrics in isolation can be misleading or irrelevant. A fund that produces 3x invested capital and a 30 percent IRR is a stellar performer, but of limited value to a large investor if it is only $150 million in size, or if it took huge risks to make those returns.
Oliver Gottschalg, associate professor of strategy at HEC Paris and co-founder of its private equity observatory research centre, discussed this with a client earlier this year.
In Gottschalg’s own words:
“I met with Bart Elema, CFO of my client Waterland Private Equity, and he mentioned to me that based on his research in industry specific databases, there were only very few PE funds of a certain size that generated more than 3x net.”
“We had a conversation about what aspects make a PE fund really great, as the simple money multiple is clearly too simplistic: no consideration of risk, time value of money, opportunity costs etc.
“During the conversation I realised that it is not obvious from the outside to spot the ‘best of the best’ of all PE funds of all times… and that this information would be useful for investors and for the asset class in general. It would demonstrate how strongly value creating private equity as an asset class and a governance structure can be – countering some of the widespread criticism that private equity only levers up equity and rides macro trends.
“It would also give investors some idea about which GPs had been at the top of this ‘game’ over the past 20 years. On the way back from the meeting, I started to sketch out the set of complementary hurdles that a PE fund would have to surpass to deserve the label of being among ‘the best of the best’ at value creation in PE.”
Gottschalg settled on three key hurdles, and the idea of the ‘HEC Private Equity Value Creation Hall of Fame’ was born. In order to qualify for the Hall of Fame, funds must have generated:
- at least $2 billion in cash-on-cash alpha gain;
- “PERACS Alpha”* of at least 15 percent return;
- at least 2x cash-on-cash multiple.
Gottschalg and his team set about analysing data on realised returns for 2,500 funds and, as Elema predicted, rapidly whittled them down to a handful of exceptional funds.
Here we launch the HEC Private Equity Value Creation Hall of Fame, with its first inductee: Hellman & Friedman Capital Partners IV. Watch out for further admissions in the coming months.
Our first entrant is the 2000-vintage fourth fund from San Francisco-based Hellman and Friedman. The fund raised $2.2 billion and by the time it was fully liquidated had returned a net multiple of 2.8x to investors.
Headline performance data**
Net IRR: 35.6% (top quartile)
PERACS Alpha: 22.3% (top quartile)
Distributed to Paid In: 2.8x
Total Value to Paid In: 2.8x
According to PERACS, the performance analysis consultancy founded by Gottschalg, the fund compares extremely favourably with its relevant peers, both in terms of net IRR and total value to paid in capital.
Peer group analysis
PERACS creates a peer group of relevant funds by assessing a fund’s individual deals and categorising them by sector, region, 3-year timing window and size, and then finds those funds whose deals overlapped most with these “strategic cells”. The relevant peers are:
The list of LPs in H&F IV reads like a who’s who of North American pension giants, including long-time Hellman & Freidman partner the California Public Employees’ Retirement System, the Massachusetts Pensions Reserves Investment Board, the Minnesota State Board of Investment, New York State Common Retirement Fund, New York State Teachers’ Retirement System, Ontario Municipal Employees Retirement System, Pennsylvania Public School Employees’ Retirement System, Pennsylvania State Employees’ Retirement System and the San Francisco Employees’ Retirement System.
Headquarters: San Francisco
Key people: Philip Hammarskjold, chief executive officer (San Francisco); Patrick Healy, deputy CEO (London)
Recent track record: closed its eighth fund on $10.9 billion in 2014, according to PEI data. Its 2011-vintage Fund VII was returning a net IRR of 17 percent and a multiple of 1.5x, as of the latest data available from CalPERS.
Investment focus: ticket sizes of between $300 million and $1 billion in developed markets (source: State of New Jersey investment council documents)
LP views: Investors note a number of qualities that contribute to the firm’s appeal, including the strength of its track record, the stability and experience levels of the team and its deep industry expertise. One LP PEI spoke to said they were likely to commit to the next H&F fund and singled out the alignment of interest between the firm and its investors, noting that while it is now industry standard to offset monitoring and transaction costs, H&F has been doing this since inception.
John Morris, a managing director at HarbourVest – a long-time investor in the firm’s funds and an LP in Fund IV – notes that part of the firm’s success can be attributed to it investing just one pool of capital rather than multiple strategies. “The fact that the whole team is focused on one strategy gives the team a level of focus that has allowed them to outperform; their energies are not diluted.”
Countercyclical secret sauce
Mostly notable within the PERACS analysis of Hellman & Friedman, and perhaps one of the keys to the firm’s success, is its extraordinary lack of ‘procyclicality’ with its peers in terms of investment timing. ‘Procyclicality’ is defined by PERACS as a comparison of the timing of the fund’s investment patterns with the overall private equity universe. It is taken as a proxy measurement for the quality of deal flow, because it demonstrates its ability to invest when others cannot and slow down when others are speeding up.
Hellman & Friedman ranked way beyond the least procyclical quartile of its relevant peer group.
*PERACS Alpha measures value generation in excess of a public market equivalent, with the MSCI ACWI index as reference point.
** Hellman & Friedman did not comment or contribute to this article.