The level of excess returns from private equity investments compared with those in stock markets is largely dependent on the fund manager, who are often the main driver of private equity’s alpha, a new report has found.
Fund managers generate above-average excess returns when they have a high degree of industry specialisation, great expertise and particularly strong deal flow, according to the study, Finding Alpha 2.0, by Germany-headquartered fund of funds Golding Capital Partners and HEC School of Management in Paris.
Private equity’s positive alpha and the fact that it is negatively correlated with capital market performance is confirmed in the report, it said. “The analysis of this data set proves that on average, private equity transactions generate a positive alpha of five percent over the comparable return from the stock market”, said Oliver Gottschalg, professor at HEC School of Management.
The current figure obtained for alpha differs from that measured in last year’s study (7.1 per cent) mainly because additional transaction data from boom times was included in the calculation. The study demonstrates that the alpha of private equity is still negatively correlated with stock market performance. In a stable market environment the current study measures an alpha of 12 per cent, rising to 18 per cent in recessionary phases. During periods of moderate growth private equity investments generated an alpha of two per cent. Only at the top of the economic cycle do they have a negative alpha of seven per cent compared with the stock market.
“Using a very broad set of data, this study enabled us to prove that the excess return of private equity investments compared with the stock market depends above all on the fund managers involved”, as Jeremy Golding, managing director of Golding Capital Partners, explains the results of the study. “As drivers of private equity’s alpha, factors such as the segment, region or industrial focus of the investment have no significant role to play. Apart from the fund manager the only other significant factor is the date of the investment.
“The choice of the right fund manager can improve the return of a private equity investment dramatically”, added Daniel Boege, head of buy-out at Golding Capital Partners. “Our study shows that an investment with the best 50 per cent of private equity fund managers achieved an alpha of 18 per cent. That’s why it is vital for investors to take an all-round look at fund managers in the course of due diligence and to identify the criteria that make them successful.”
According to the study, fund managers generate above-average excess returns when their portfolios exhibit a high degree of industry specialisation, when they have particularly strong deal flow and when they can demonstrate their qualitative expertise by the alpha generated to date. By contrast the number of completed transactions is not a significant factor for a fund manager’s performance.
The empirical study is based on data from over 4,200 realised private equity transactions carried out in Europe and the US between 1977 and 2010.
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