Setting the Benchmark: Spotlight on Private Equity

Abstract

What is Benchmarking?

Benchmarking is the process of comparing a firm’s business processes and performance metrics to those of the firm’s industry or another industry. The benchmarking process may focus on specific segments of the industry such as the top-performing firms or the “average” firm. Dimensions typically measured are quality, time, cost, risk and return. The term benchmarking was first used by cobblers to measure people's feet for shoes. They would place someone's foot on a "bench" and mark it out to make the pattern for the shoes. In the investment industry, benchmarking is the process of finding a quantifiable standard against which to measure a portfolio’s performance. The focus of this essay is on benchmarking for investment products and in particular for private equity investments. First, we discuss the desirable properties that a proper benchmark should possess. Second, we present a framework for classification of asset classes depending on the liquidity of the product itself, liquidity of its underlying assets, and to the degree that the product is actively managed. Third, we discuss two broad approaches to benchmark construction and then discuss the role of benchmarks in the evolution of asset classes. Finally, we examine various private equity benchmarks and discuss their properties.

Keywords: Alternative Assets, Private Equity, Benchmarking, PME, Valuation