Limited partner drawing on past funds' performance for investment decisions may be working from an incomplete picture
Despite the evidence linking private equity funds’ outperformance with success in subsequent funds launched by the same manager, limited partners making decisions to invest in new buyout funds should probably still think twice before being swayed by past funds’ good showing.
According to a new working paper from the National Bureau of Economic Research, previous studies documenting performance persistence among buyout funds were based on final outcomes of private equity funds. But as explained in Institutional Investor, the reality is that most investors decide to invest in a follow-up fund while the predecessor funds are still operating.
To determine how reliable past performance actually is for limited partners considering a new fund, the proponents of the study looked at performance persistence based on “the information an investor would actually have — previous fund performance at the time of fundraising.”
Using private equity data from Burgiss, the researchers looked at the performance of 893 buyout funds and 1,329 venture capital funds launched between 1984 and 2014.
“We find little or no evidence of persistence, for buyouts, both overall and post-2000,” said authors Robert Harris, Tim Jenkinson, Steven Kaplan, and Ruediger Stucke. “The conventional wisdom to invest in funds that are, at the time of fundraising, reporting top quartile returns does not hold for buyouts.”
The authors noted that very few general partners raise a fund when their previous funds are in the bottom quartile of performance. The fact that PE managers raise new funds when their previous funds are doing well, they said, contributes to the lack of persistence in the performance of buyout funds.
When it came to venture capital, however, the authors found evidence of persistence when using information on the performance of both the previous and second previous funds at the time of fundraising for a new fund.
“The stronger performance persistence for VC as compared to buyout suggests that GP skills and networks for successful VC investing are harder to replicate than is true in buyout,” they said.
