Study suggests tendency for reported values to peak right before fundraising is real, but not intentional
Investors may become understandably curious when a private equity fund’s reported value reaches its highest level just as the general partner embarks on a new round of fundraising; some might even suspect the managers of manipulating their results to look more favourable. But new research suggests a less-than-sinister explanation.
“In a new academic paper, assistant finance professor Niklas Hüther [of Indiana University] analyzes the previously documented tendency of net-asset values to peak during fundraising periods,” reported Institutional Investor.
Based on a study of 121 U.S. buyout funds raised between 1996 and 2010, with proprietary data from “one of the largest international” in the world, Hüther confirmed that fund values peak at a fortuitous time — right at the onset of new fundraising.
But based on an analysis of the underlying buyout deals, he determined that the timing of net-asset value peaks is not due to behind-the-scenes efforts to exaggerate performance. Instead, he found that it arose from general partners making their best deals early in their fund’s live cycles. As a result, the PE portfolio value rises just before the new fundraising activity commences, boosting the overall fund’s net-asset value.
Such pre-fundraising highs are further emphasized, Hüther found, by a contrasting tendency of PE managers to strike the worst deals immediately before fundraising. As reported by Institutional Investor: “These portfolio companies eventually decline in value and drag the overall fund’s net-asset value down from its fundraising-period peak.”
According to one explanation offered by Hüther, PE managers are more prone to making bad deals right before raising a new fund as they are “pressured to invest unspent capital before fundraising.”
He also found that the amount of pressure faced by funds tended to differ based on their reputation among investors, with more well-reputed funds paying about 35% less for portfolio companies one year prior to fund raising compared to those with worse reputations.
“This premium is in line with the approximately 35 percent drop in post-fundraising deal performance of low-reputation funds,” Hüther said, concluding that inferences about manipulation are “inconsistent with the deal-level evidence on fundraising.”
