2: Private Equity Flashcards
Bailey’s criteria for an appropriate investment benchmark
Unambiguous Investible Measurable Specified in advance Appropriate (for what is being measured)
RPVI (residual value to paid in ratio)
Measures how much of investor’s capital is still tied up in the fund.
RPVI = NAV / paid-in capital
TOPSCAN framework
Team building Operations Perspective Skill building Customer development Analysis Network
Key performance drivers for PE
Selection of fund manager
Management of diversification
Management of capital commitments
What are the resources that VCs should assess in terms of their value proposition?
- Brand resources
- Cash resources
- In house expertise
- Network resources
Benefits of FoF investing (4)
Diversification and intermediation
Resources and information
Selection skills and expertise
Incentives, oversight and agreements
Hurt money
GP’s contribution
Type 1 conflict
Conflict between firm’s and client’s interests. Mitigated by aligning interests
Type 2 conflict
Firm favors one client to detriment of another. Worse than type 1
Steps of PE investment process (6)
Portfolio objectives Portfolio design Liquidity management (over commit) Fund selection Monitoring Actions and implementation
Bottom up
Find best manager
Drawback: can result in unbalanced/risky portfolio
Top down
Focus on sector or strategy
Drawback: strict allocations may be impractical to attain
Advantages of core satellite
Diversification
Customization
Target risks
Focus on satellite portfolios
Effects of diversification
Lowers risk, return, skew and kurtosis
20-30 funds diversifies 80% of SD; 5 funds diversify 80% of K
Market timing
Predict vintage years that will perform well
Issues: PE markets over react to news
Cost averaging
Invest consistently in each fund type each vintage year (ie vintage year diversification)
Fund manager selection process
Wish list
Deal sourcing
DD
Decision and commitment
Drawback of IIRR
Assumes distributions reinvested at IIRR. Solution is to use modified IRR as it assumes a different investment rate and accounts for cost of capital
Drawbacks of paid in ratios
Ignore TVM and requires estimates of NAV
Potential actions for poorly performing funds
Do not commit to follow on funds Negotiate for change Petition for lower management fees Threaten action against or terminate managers Investor default
Pro for using NAV
Investors prefer valuation based on current (not future) information
Cons for NAV
Private funds cannot be divided up into underlying portfolio companies
Aggregate NAV does not reflect economic value
NAV does not reflect economic value. why?
It doesn't account for: Undrawn commitments Value add provided by managers Future fund expenses Capital constraints
Shortcomings of CAPM
Assumes the following: No transaction costs Fully informed buyers and sellers Tradable assets Markets always in equilibrium