Top Quartile PE Managers: Does Performance Really Persist?

(August 7, 2013) – Momentum strategies may be better applied to equity markets than buyout funds, four researchers have found. 

Up until the turn of the millennium, the study determined that private equity performance tended to persist year-on-year for top quartile funds. The trend continued from 2000 through 2011 for venture capital funds, but ceased to be clear for buyout funds. 

The study, “Has Persistence Persisted in Private Equity? Evidence from Buyout and Venture Capital Funds,” was authored by finance scholars Robert Harris of the University of Virginia, Steven Kaplan of the University of Chicago, and Oxford University’s Tim Jenkinson and Rüdiger Stucke.

The scholars used cash flow data drawn from more than 200 institutional investors and covering the years 1984 through 2011, which was provided by portfolio management software firm Burgiss. The data set represented portfolios totaling more than $1 trillion in committed capital, with roughly two-thirds of the investors having private equity allocations in excess of $100 million. 

After 2000, the study found that 78% of top-quartile buyout funds dropped out of the top tier, and only beat median performance 50.8% of the time.

Performance trends tended to be more persistent with the weakest buyout firms: bottom-quartile funds only broke above median performance 35.7% of the time.

For venture capital firms, the researchers found top-quartile was a better indication of future performance than with buyout funds.

“We find that performance more or less remains as statistically and economically persistent as pre-2000,” the authors wrote.

Capital invested in a previously top-quartile venture capital fund could expect to earn 226% above the S&P 500 over the life of the fund. For a bottom quartile fund, an average investor could expect gains 21% below what they’d earn in an public equity index.  

“These results imply much greater stability in the venture capital industry over time. The same forces that operated in the 1980s and 1990s appear to still be in effect.”

Many institutional asset owners also still put stock in the top-quartile performance designation, including New Jersey’s pension system. 

One of the first things the fund’s Chairman Bob Grady did when he took over the position was propose limiting alternatives allocations to top quartile managers. The board passed his resolution unanimously, and the rule has persisted.

“When any manager comes to our door, that question is always, always asked of the consultant and of the staff,” Grady told aiCIO in January. “We say, ‘Show me the records. Show me the data. Show me the Preqin. Prove that they’re top quartile.’”  

Read Robert Harris, Steven Kaplan, Tim Jenkinson, and Rüdiger Stucke’s study here.

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