The quest for standardisation

When any GP can claim to be a top performer, the industry needs some standard measure of greatness for the benefit of truly excellent managers and limited partners, writes Oliver Gottschalg.

The current fundraising market is awfully tough for general partners, but not just because there are so many asking for money. GPs are to some extent haunted by two things today that played out in their favour in the past. First is the ambiguity in terms of methodologies for how to identify and quantify certain aspects of their track record, and second is the multiplicity of available benchmarks and reference points to look at.

We did a study that quantitatively showed that more than 75 percent of all GPs can indeed claim top quartile status for their funds as long as they choose – in an intelligent way – what they would like to be compared to. There’s hardly any conference where I don’t see somebody on the stage mentioning this these days, and it’s good that the insight is out there now.

A similar thing is going on when you look at alternative ways to just measure performance or quantify the sources of value, such as how much of the return is attributable to top line growth versus margin effect versus just paying down debt. Placement agents joke among themselves that there are probably as many different methods to do this out there as there are different GPs.

Oliver
Gottschalg

The result of all this is that everybody somehow finds a way to look outstanding, and that leads to a fair amount of frustration among the GPs, especially those who have the right to consider themselves to be the real outperformers, because they’re stuck in this jungle of imprecise measurers, questionable methodologies and different benchmarks. They don’t have a way currently to show to the LP community that they are indeed the outperformers.

This is equally frustrating for the LPs because how do you possibly pick the right funds if everybody somehow looks great?

Something we are working on is how you can combine the available data out there, look at the different methodologies and try to move to a few standardised indicators of performance. The approach is to try to identify the funds that are really similar in the type of deals that they’ve chosen, with the idea that an algorithm can quantitatively and very objectively derive that peer set. Once the GP can say, “These are the peers that are algorithmically derived as the most similar competitors”, you can come to a very meaningful comparison.

Many GPs have told me that identifying a standard for measurement and quantification for not just performance but also risk and possibly some aspects of strategy would be a quantum leap for the industry and also make it easier for the asset class to attract fresh capital.

While it would probably harm some of the mediocre performers who hide behind questionable numbers, attracting a few more percentage points of the $50 trillion of investible capital that is outside private equity would do something drastically good for the asset class. I don’t see this as a fundamental change that’s coming in 2013 in the way that LPs evaluate prospective GPs, but I certainly think the process is undergoing an evolution.

Oliver Gottschalg is a private equity researcher at Paris-based HEC School of Management.