Lecture 9: Performance of PE: academic perspective

Question 1

When can a fund’s performance be measured?

Answer 1

After the liquidation of the fund (i.e. when all portfolio companies have exited) the exact timing and amount of all cash flows in fully available –> measurement without error based on actual cash distribution
The performance evaluation before is based on estimates of portfolio company worth.

Question 2

What does the J-curve show?

Answer 2

The cumulated cashflow = cash distributions of payouts - draw downs (drawing committed capital for investment activities)

Question 3

Three main measures of PE fund performance

Answer 3

• IRR
• Return Multiples
• Public Market Equivalent (PME)

Question 4

investment horizon

Answer 4

entire funds lifetime not investment period

Question 5

Pros of the IRR

Answer 5

• considers all cash flows
• factors in the time value of money

Question 6

Cons of IRR

Answer 6

• does not factor in risk
  -ignoring the size of CF might lead to faulty decisions
• complex arithmetic
• calculation is highly sensitive to timing of CFs

Question 7

How can the IRR be boosted?

Answer 7

By exiting early. So positive cash flow comes in early. –> Might not be optimal decision for investors

Question 8

What are return multiples?

Answer 8

Multiple = returns from the fund/ invested money

Question 9

What are the three multiples normally reported?

Answer 9

• Distributed value to paid-in ratio (DVPI)
• Residual value to paid-in ratio (RVPI)
• Total value to paid-in ratio (TVPI)

Question 10

What are the cons of the return multiplers?

Answer 10

• time value of money is ignored
• risk is not captured

Question 11

When can DVPI be measured

Answer 11

At any time. Usually negative at the beginning of the J-curve

Question 12

How is TVPI calculated?

Answer 12

DVPI + RVPI

Question 13

PI

Answer 13

The “paid-in” (PI) in TVPI, DPI and RVPI represents the total amount of capital called by a fund (for investment and to pay management and other fees) at any given time.

Question 14

DI

Answer 14

• The “distributed” (D) in DPI represents capital that has been returned to fund investors following the sale of a fund’s stake in a portfolio company.

Question 15

RV

Answer 15

• The “residual value” (RV) in RVPI represents the fair value of the stakes that a fund holds in its portfolio companies and is measured by its net asset value (NAV).

Question 16

PME

Answer 16

Public Market Equivalent

• index return measure benchmarking private investing performance with public equity markets

Question 17

Pros of PME

Answer 17

• takes alternative investment opportunities into account

Question 18

Cons of PME

Answer 18

• tricky to define similar investments. Public investments would need to match the PE investments in terms of
• CF timing
• systematic risk pattern of PE

Question 19

What does a PME >1 mean?

Answer 19

That the unit at hand (fund) has performed better than the public market used as a benchmark. Vice versa

Question 20

When was there a high IRR for VC funds? When was there a negative IRR?

Answer 20

There was a high IRR of 44% before 1999 whereafter the IRR declined.

Question 21

Who took the best investment decision based on IRR of all the types of investors (before 1999)

Answer 21

University endowment funds

Question 22

Do currently PE or VC firms provide higher returns?

Answer 22

PE

Question 23

Is there usually a large variance in term of performance between the investor types?

Answer 23

No

Question 24

What is the mean spread for a gross fund return of 2.2-2.4MM?

Answer 24

.42MM

Question 25

Is past performance of PE funds indicative of future performance?

Answer 25

It was so in the past, but in recent years this does not really hold anymore.

Question 26

Can persistence be shown on deal level?

Answer 26

Yes.

Question 27

Is performance in PE persistent if competition is high?

Answer 27

No. If competition is high, performance by PE fund managers is significantly less persistent. In particular PE fund managers doing a successful deal are less likely to repeat this with following deals.

Question 28

Does it pay off to pay premium fees to funds that were in the top quartile in the past?

Answer 28

Not necessarily