Think tank takes private equity to task

The Centre for the Study of Financial Innovation - in contrast to recent studies by academics - alleges the industry has reported deceivingly high returns because it failed to account for leverage.

A recent report on private equity says strong returns have in the past been presented as better than they actually were and that private equity firms should be required to publish performance data for independent analysis on an annual basis.

The report, by the Centre for the Study of Financial Innovation, references a Yale University study of 542 contemporary buyout deals that were reported as having outperformed the stock market. But the study from the UK think tank alleges the group of deals in actuality underperformed by nearly 40 percentage points per annum after factoring in the impact of “extra debt”.

“Yale's findings undermine the credibility of those who cite the legendary track records of large American endowments in support of investing in private equity,” the report said.

Improved transparency, the report suggests, should come in the form of mandatory annual reports from private equity firms, as well as requirements that those firms “also submit annual data about their investments that allow [accounting firms] to perform some independent analysis”. The report claims annual data reviews previously published by private equity firms “lack real substance – such as independently calculated performance track record”.

The report also criticises current fee structures by claiming that realised returns do not justify the level of investment. “Fees (including carried interest) should be based on the specific contribution of the private equity firm, not on the total return.”

The CSFI is a not-for-profit think tank established in 1993 that looks at emerging threats and opportunities in the financial services sector.

Its findings are at odds with recent studies including an independent analysis conducted by HEC Paris and London Business School, which after stripping out the effects of leverage and other factors including sector differentiation, found that buyout funds do produce a unique alpha component.