Past Performance Key to Future Returns (at Least in Private Equity)

More than three quarters of private equity investment consultants believe past performance is a guide to future performance, research by Preqin has found.

The research firm questioned 40 consultants about the most important due diligence factors to assess when selecting private equity funds.

It found that 83% of consultants “stated that the best key indicator that a fund will outperform peer funds is a successful performance track record at a team level”—a statement that doesn’t sit well with the conventional investment wisdom that past performance is no guide to future performance. The group also surveyed 100 placement agents, 81% of whom agreed that a “successful performance track record at a team level” was the most important indicator of future outperformance.

Preqin’s number-crunching of performance data did find a correlation between good performance over four and six years, and strong 10-year performance—which is typically the lifespan of a private equity fund.

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It found 64% of funds that ranked in the top quartile for performance over four years were also top quartile after 10. Of funds in the top quartile after six years, 79% were top-quartile after 10 years.

preqin pe quartiles

The research group argued that investors could use this interim data “as a good indicator of funds’ overall performance”, which could be helpful when deciding whether to back new iterations of existing strategies.

When asked by Preqin about assessing first-time fund managers without track records, Sanjay Mistry, director of private debt at Mercer, said: “First-time funds really need to demonstrate the qualities of an established general partner in many regards in order to secure allocations. This is especially true when there are more funds than ever seeking capital.”

Mistry cited the investment history of individuals and understanding the cohesion of the team as important elements of due diligence for new offerings.

The 40 consultants quizzed by Preqin also sent out confusing messages when naming the most important factors to consider when private equity managers are fundraising.

The group said: “74% of investment consultants surveyed by Preqin state that a fund manager needs a successful performance track record at a team level to meet its fundraising target, whereas only 63% say that having a successful performance track record at a firm level is the most important trait needed.

“However, when naming warning signs that a fund manager will not successfully fundraise, 83% of investment consultants surveyed named poor performance track record of a firm as a warning sign and 80% named poor performance track record of a team.”

Stuart Taylor, head of investor products at Preqin, said the research suggested that private equity investment groups with overall poor track records “may find it difficult to attract interest from consultants and their clients”. If these firms were to bring in new teams, he added, “they will need to emphasize this to potential new investors in order to secure their capital”.

The full report can be found here.

Foundations in the US had another stellar fiscal year in 2013, riding strong equities markets to average investment returns of 15.6%.

This is the second year in a row private charities have earned double-digit gains on their portfolios, according to research by the Commonfund Institute and Council on Foundations. The 153 institutions covered in the study together held assets worth $94 billion at the year’s end.

Consultant use declined year-on-year, from 80% to 73%. Amid these large gains, foundation dialed back their reliance on consultants and outsourced-CIO operations. The portion either outsourcing or considering it fell by 9 percentage points over the year. In 2013, 69% of those surveyed managed portfolios internally with no plans of handing off control, up from 57% in 2012.

Consultant use likewise declined year-on-year, from 80% to 73%.

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Foundations did not tend to compensate for the reduction in external help with internal hires. The average non-profit employed 1.3 full-time investment specialists, down slightly from 1.4 the year prior.

Asset managers have taken up the slack, instead. The average foundation had 153 managers on its roster in 2013—13 more than in 2012.

Alternative investment firms took up the majority of foundations’ manager rosters, while appetite for these strategies remained steady. The typical charity dedicated 42% of its portfolio to hedge funds, private equity, venture capital, commodities, and real estate, among other alternatives.

Stocks accounted for roughly the same portion of assets (44%) as alternatives, and fueled investment returns.

Relative to pension funds, foundations tend to prefer growth assets and alternatives to fixed-income exposure—a bias that paid off in 2013. The typical 9% bond allocation—which had shrunk by a third since 2011—lost 0.7% over the year.

With investment gains mounting, most foundations reported spending more on their charitable activities than the previous year.

John Griswold and Vikki Spruill, the heads of the Commonfund Institute and Council on Foundations, respectively, called their findings “good news” for the US.

“As foundation assets continue to rebound,” Griswold and Spruill noted, “they have more resources to invest in programs that advance the common good.”

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