Measuring Risk for Venture Capital and Private Equity Portfolios

Abstract

The standard approach to measuring portfolio risk - regressing portfolio returns on market returns - seriously understates the risk of venture capital, buyouts (private equity), real estate, and other alternative assets not traded in active markets. Institutional investors, having a sense of the bias, often use a stock market index plus a premium (S&P500 5, or Russell3000 3) as a benchmark, or attempt to evaluate portfolios using public market equivalents. The bias arises from the use of stale valuations in the calculation of return. I present an approach to measuring risk that fully addresses the staleness issue. The approach extends the standard regression by adding lagging market returns. Examples for venture capital and buyout portfolios show that the true risk is generally more than double the level found in the regression lacking adjustment for stale valuations. The extended regression also reveals the staleness profile of each portfolio. From that profile, I show how to calculate a mark-to-market value for the portfolio. This paper updates my earlier papers using additional data from recent quarters.

Keywords: venture capital, private equity, risk, performance, measurement, mark-to-market

JEL Classification: C22, G24