Why Endowments Outperform in Private Equity

How often do you check up on your general partners (GPs)? Research has suggested that high reporting frequency in private equity is a sign of good governance in GPs and limited partners (LPs) alike—and could lead to better overall performance.

“Reporting frequency can serve to mitigate information asymmetry and agency problems, and also serve to proxy for good corporate governance.”The more regularly a fund reports to its LPs, the less likely it is to overstate performance, according to the study. Investors are consequently armed with better information and can make better investment decisions, argued Sofia Johan and Minjie Zhang of York University’s Schulich School of Business in Ontario.

“Fund managers have significant incentives to overstate their performance to investors,” they explained. “Reporting frequency can serve to mitigate information asymmetry and agency problems, and also serve to proxy for good corporate governance.”

Frequent performance reports were a strong indicator of GP governance efforts and effective monitoring by LPs, the researchers found. LPs may require regular updates as part of “stringent” partnership agreements, Johan and Zhang said.

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Endowments in particular were shown to employ the best governance practices in private equity, receiving more frequent reports than any other class of LP.

“Endowments also perform relatively better than other LPs as institutional investors in LP investments, and we believe that is a result of a strong but robust effect from the reporting behavior of private equity fund managers,” Johan and Zhang wrote.

For the study, the researchers used PitchBook’s private equity database, examining the performance and reporting behavior for 5,068 private equity funds and 492 LPs from 2000 to 2012. They found that the frequency of performance reports received by endowments was “significantly higher” than it was for other LP types—and that those reports were also less inflated than the ones fund managers gave to other LPs.

Since endowments were also the best performing LPs in the study, Johan and Zhang suggested that the good governance exhibited by these investors and their GPs could be the “secret of their success.”

Read the full paper, “Reporting Bias in Private Equity: Reporting Frequency, Endowments, and Governance.”

Active managers can and do outperform passive strategies—but only if they are focused, disciplined, and retain a single investment process, according to Northill Capital.

“The average outperformance relative to benchmarks has been more than sufficient to fully offset the impact of institutional fees.”Managers “focused on a single core skill set” were shown to have “significantly” outperformed managers from generalist firms and passive funds over five years ending 2015.

“In many fields of human endeavor specialization results in superior performance,” Northill’s report stated. “The same truism applies to asset management. Our research demonstrates a clear and persistent link between the managers who focus on a single core skill set and their success in delivering outperformance for their investors.”

Northill—which provides start-up capital to investment boutiques—compared the performance of more than 2,000 active US equity funds. The “most focused” funds—defined as those with a single investment process and a disciplined approach to capacity—added 116 basis points of performance a year above their benchmarks, Northill reported.

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The effect was similarly evident in European equities, emerging market equities, and to a lesser extent in global equities, Northill found.

“The average outperformance relative to benchmarks generated by the most focused managers has been more than sufficient to fully offset the impact of institutional fees on performance in each of the asset classes we have examined with the exception of global equities,” the report continued.

“Average” active managers in US fixed income, global equities, and US equities failed to outperform their benchmarks after fees during the period reviewed, Northill found.

“In truly focused active asset management firms all professionals work as one team to deliver the best possible investment results,” said Jon Little, partner at Northill Capital. “The key decision makers also tend to hold a meaningful proportion of the firm’s equity. Their success and the long-term value of the firm are defined solely by the outcomes delivered for all clients.”

Asset management firms with multiple strategies, processes, and asset classes risk becoming “sidetracked” from investment performance, Little argued. “These tensions destroy teamwork, damage firm culture, and distract investment professionals,” he said.

In contrast, a clearer alignment of interests between asset owners and specialized managers “maximizes the probability that investors will achieve long-term successful investment outcomes,” Little argued.

Read Northill Capital’s full report, “Nowhere to Hide: Focused Active Asset Managers Outperform.”