Although top-quartile private equity funds tend to outperform the public market, private equity as an asset class on average yields “minimal and statistically insignificant” outperformance compared to “equally risky public market investments”, according to recent research by consulting firm Peracs and software company eFront.
Data from a sample of 701 buyout funds from the US and Europe with an aggregate size of $360 billion, taken over a seven year period, was used to determine net-of-fees performance – called “modified internal rate of return” in the report – for funds and their public market equivalent benchmarks.
On average, buyout funds in the sample generated a 7.6 percent modified IRR, versus 6.8 percent in public markets. Top quartile funds, however, generated a 13.6 modified IRR compared to 8.5 percent from public market investments with the same risk profile. The 5.1 percent (510 basis points) difference “is not only of considerable economic magnitude, but also of high statistical significance”, the study says.
The study also finds that the traditional approach for evaluating private equity performance by measuring IRR and as compared to long-term stock market returns is “inaccurate and misleading” because it ignores “the irregularly timed cash flows of private equity fund investments and the differences in operating and leverage risk between private equity fund investments and ‘the market’ as captured by these indices.”
Peracs, which provides quantitative analytics for private equity fund due diligence, is led by Oliver Gottschalg, associate professor of Strategy and Business at the HEC School of Management Paris.