Do You Get What You See in Private Equity? A Bayesian Decomposition of Investment Skills

60 Pages Posted: 21 Nov 2022

See all articles by Alexander Juergens

Alexander Juergens

Technische Universität München (TUM) - TUM School of Management

Reiner Braun

Technische Universität München (TUM) - TUM School of Management; Center for Entrepreneurial and Financial Studies

Yichun Dong

Technical University of Munich

Date Written: November 4, 2022

Abstract

Analyzing a large sample of gross fund-level and deal-level returns in Private Equity (PE), we study systematic differences in investment skills across PE firms and what investors can learn about the true skill of PE firms from past performance. We extend the framework of Korteweg and Sorensen (2017) and establish a flexible variance decomposition model that estimates heterogeneity in returns, idiosyncratic risk-taking, and default risk. Our results show that investment skills are systematically different across PE firms with an estimated interquartile spread of returns ranging from 23% to 26% for deals and 17% to 21% for funds, relative to the market. Further, we find significant heterogeneity in idiosyncratic risk and default risk, but higher idiosyncratic variation does not explain higher expected returns. Since returns inherit substantial noise and spurious correlations from overlapping investments, investors require a considerable number of observations to learn about the true skill of PE firms.

Keywords: Private Equity, Leveraged Buyouts, Persistence, Skills, Institutional Investors

JEL Classification: C11, C15, C18, D83, G11, G23, G29, G30

Suggested Citation

Jürgens, Alexander and Braun, Reiner and Dong, Yichun, Do You Get What You See in Private Equity? A Bayesian Decomposition of Investment Skills (November 4, 2022). Available at SSRN: https://ssrn.com/abstract=4270851 or http://dx.doi.org/10.2139/ssrn.4270851

Alexander Jürgens (Contact Author)

Technische Universität München (TUM) - TUM School of Management ( email )

Freising
Germany

Reiner Braun

Technische Universität München (TUM) - TUM School of Management ( email )

Arcisstr. 21
Munich, Deutschland 80333
Germany
+498928925181 (Phone)
+498928925188 (Fax)

HOME PAGE: http://www.ef.wi.tum.de/

Center for Entrepreneurial and Financial Studies ( email )

Arcisstrasse 21
Munich, DE 80333
Germany

Yichun Dong

Technical University of Munich ( email )

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