I enjoyed listening to a panel this morning sponsored by Broadgate Consultants on “Raising Fund “x”: Trends in Private Equity Fundraising and Fund Evaluation.” My rough notes follow:
Panelists were:
- Dr. Oliver Gottschalg, Assistant Professor of Strategy and Business Policy, < ?xml:namespace prefix = st1 ns = “urn:schemas-microsoft-com:office:smarttags” />HEC School of Management; Co-director, HEC-INSEAD Buyout Research Group
- C. Scott Hamner, Director, Credit Suisse Customized Fund Investment Group
- Jesse E. Reyes, Managing Director, Bear Stearns Private Funds Group; Founder, Reyes Analytics
Reyes: Buyout market bifurcated between very large firms and very small. Everyone now wants to go mid-market (defined as under $1b to under $6b).
Distributions have been coming back to LPs very slowly, so they have less capital to invest.
Hamner We represent pensions and other large investors. We act as an investor/fiduciary on behalf of those clients, and are an intermediary here.
Quality and volume of funds is much greater now than it was in the past.
We’re seeing a convergence of our investor criteria.
We have a much larger universe of funds in which we can invest.
Bar for new manager relationships is higher than managers we’ve known in the past.
Gottschalg: “Top quartile paradox”.
A lot of LPs unhappy with past performance of their investments.
Q: Subjective or objective criteria more important?
Reyes: “People eat multiples not IRR.”
Gottschalg: Multiples and IRRs are both misleading. A better measure is to move to a better standard on which performance can be objectively reported.
Q: What is your advice to new managers?
Reyes: I see a lot of shotgun marketing in the LP business. You should only be focusing on funds that are a fit for what you invest in/your stage.
The attribution of your track record is important, i.e., who in your fund did what.
The devil you know is better than the devil you don’t.
Differentiation/knowing your customer is paramount.
Q: What is the effect of the growth of the secondaries investing market?
Gottschalg: This industry will move to more objective reliable performance measures, a ratings-type model.
A more liquid secondary market opens up a whole new toolbox for how you invest in this sector, and changes how you think about investing in this area.
Gottschalg: What are obstacles in the way of this industry realizing the division that you outlined?
Inefficiencies in the market help top PE firms get great returns.
Reyes: Is being top quartile in Fund 1 correlated with being top quartile in Fund 2?
Q: How does GPs marking to market impact how you do business?
Reyes: 95% correlation between VC returns and Nasdaq; 60% correlation between buyout returns and S&P 500
Question from fund that brags about its capital efficiency, and asked for details on metrics that the panel recommends for evaluating fund performance.
Reyes: Capital efficiency is not a gating item, it’s a differentiator.
Teten: What metrics are fairest for judging private equity vs. hedge funds and other investments?
Reyes: Some relevant research on this topic by Austin Long, of U. Texas, and Jeremy Collard.
People tend to use just multiples, not IRRs. “It’s hard to compare an IRR with an index.”
3 elements to consider in designing a performance measure:
– overall multiple
– duration
– risk level you are taking
(Teten: I’d also add you should measure how much capital you use immediately vs. later.)
Hamner: Two main comparables:
– a public index (S&P 500, Russell 2000)
– Cambridge Associates US Venture Capital Index/Thomson Venture Economics index
Q: How do you measure performance when PEs take a long time to put capital to work?
Reyes: “Just in time” financing is the solution for this, that is a tool to boost IRR to the highest possible level.
