Private Equity Funds’ Performance, Risk and Selection
EDWARD ELGAR'S RESEARCH HANDBOOK ON HEDGE FUNDS, PRIVATE EQUITY AND ALTERNATIVE INVESTMENTS, Phoebus Athanassiou, ed., Forthcoming
36 Pages Posted: 9 Jul 2010
Date Written: July 8, 2010
We review the literature on the risks and returns of private equity funds, comparing the different datasets used in academic research. Irrespective of the datasets used, average returns seem to be lower than public equity returns and, in any event, less spectacular than often conjectured. Buyout funds seem to bear a moderate market risk (beta is around unity), but their exposure to liquidity risk and distress risk is significant. The cost of capital of buyout is 18% (in excess of risk-free rate). The beta of venture capital seems much higher (around 3), implying a cost of capital of about 20% (in excess of risk-free rate and any venture capital liquidity risk premium). We conjecture on why industry benchmarks show different returns than those documented here. Finally, we discuss fund selection. We emphasize the importance of a bottom-up approach when investing in private equity, show that top-quartile returns and evidence of performance persistence should be approached with some caveats in mind, and describe variables that have predicted returns.
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