Cyclicality, Performance Measurement, and Cash Flow Liquidity in Private Equity

Abstract:     
Public and private equity waves move together. Using quarterly cash flow data for a large sample of venture capital and buyout funds from 1984-2010, we investigate the implications of this co-cyclicality for understanding private equity cash flows and performance. In the cross-section, varying the beta used to assess relative performance has a large effect near a beta of zero, but only a modest effect for more reasonable beta estimates. For instance, buyout funds outperform the S&P 500 by 18% over the life of the fund, and moving to a beta of 1.5 only reduces this to 12%. A similar message comes through in the time series. Though funds raised in hot markets underperform in absolute terms, this underperformance is sharply reduced by a comparison to the S&P 500, and disappears entirely at the levels of beta recently estimated in the literature. These findings imply that high private equity fundraising forecasts both low private equity cash flows and low market returns, suggesting a positive correlation between private equity net cash flows and public equity valuations. Indeed, while both capital calls and distributions rise with public equity valuations, distributions are more sensitive than calls, so net cash flows are procyclical and private equity funds are liquidity providers (sinks) when market valuations are high (low). Venture cash flows and performance are considerably more procyclical than buyout. Debt market conditions also have a significant impact on cash flows. At the same time, most cash flow variation is idiosyncratic across funds, and most predictable variation is explained by the age of the fund.

Number of Pages in PDF File: 51

Keywords: Private Equity, Cash Flows, Performance, Fees, Carried Interest, Capital Commitments, Crisis

JEL Classification: G01, G23, G24

working papers series