Robert S. Harris, Tim Jenkinson and Steven N. Kaplan
Private Equity Performance: What Do We Know?
Journal of Finance | Volume 69, Issue 5 (Oct 2014), 1851–1882

Prior research on the performance of private equity investing (including both buyout and venture capital funds) has led to mixed conclusions. This is perhaps not surprising given concerns about the lack of high quality data for research. For instance, some private equity (PE) data sets rely on voluntary reporting by funds or on Freedom of Information Act requests which may result in biased samples and incomplete data. We use a new research-quality data set of PE fund-level cash flows from Burgiss. The data are derived entirely from institutional investors (the limited partners) for whom Burgiss systems provide record-keeping and performance monitoring services. This feature results in detailed, verified, and cross-checked investment histories for nearly 1,400 PE funds derived from the holdings of over 200 institutional investors.

Our research highlights the importance of high quality data for understanding PE and the returns it provides to investors. Here we focus on results using the public market equivalent (PME) method of Kaplan-Schoar (JF 2005). PME is a market-adjusted multiple which compares how much a PE fund investor actually earned net of fees to what the investor would have earned in an equivalent investment in the public market. A PME above 1.0 signals higher returns to private compared to public equity. After summarizing conclusions, we present key empirical results.

Buyout fund returns have exceeded returns in public markets

Our results are markedly more positive for buyout funds than research has previously documented. It seems likely that buyout funds have outperformed public markets, particularly the S&P 500, net of fees and carried interest, in the 1980s, 1990s, and 2000s. Our estimates imply that each dollar invested in the average buyout fund returned at least 20% more than a dollar invested in the S&P 500. This works out to an out performance of at least 3% per year. The conclusion that there has been out-performance is relatively insensitive to assumptions about benchmark indices and systematic risk. For the more recent and less fully realized vintage funds, however, eventual performance will depend on the ultimate realization of their remaining investments. Our results (and those we estimate from other commercial data sets) imply that buyout funds outperformed public markets much more substantially gross of fees. Nailing down the sources of this out performance will be a fruitful subject.

The performance of venture capital funds has changed over time.

Venture capital (VC) funds outperformed public markets substantially until the vintages of the late 1990s, but have underperformed since. Since the 2000 vintage year, the average VC fund has underperformed public markets by about 5% over the life of the fund. Although disappointing, this underperformance is less dramatic than the more commonly quoted absolute return measures. Extant research focuses on the earlier vintage years and inevitably obtains more positive results. Again, the qualitative conclusions do not appear sensitive to assumptions about systematic risk.

Private equity performance is negatively related to the inflow of capital into the asset class.

Vintage year performance for buyout and VC funds decreases with the amount of aggregate capital committed to the relevant asset class, particularly for absolute performance (internal rates of return and investment multiples), but also for performance relative to public markets. This suggests that a contrarian investment strategy in these asset classes would have been successful in the past. The magnitudes of these relations have been greater for VC funds. Why these patterns have persisted is something of a puzzle and an interesting topic for future research.

Estimated PMEs from other data sets confirm our results on private equity performance.

Using Burgiss data within a given vintage year, we find that fund PMEs are reliably related to the more generally available absolute performance measures, internal rates of return (IRRs) and investment multiples. For both buyout and VC funds, IRRs and investment multiples explain at least 90% of the variation of PMEs in most vintage years, with investment multiples explaining substantially more of the variation than IRRs. As a result, researchers and practitioners can use our models to estimate PMEs without having the underlying fund cash flows. We do this to estimate average PMEs from three other commercial data sets on private equity, Cambridge Associates, Preqin and Venture Economics (part of Thomson Reuters). The Burgiss, Cambridge Associates, and Preqin data sets yield qualitatively and quantitatively similar performance results. There is little reason to believe that the Burgiss and Preqin data sets, in particular, suffer from performance selection biases in the same direction. At the same time, consistent with Stucke (WP 2011), we find that performance, particularly for buyout funds, is markedly lower in the Venture Economics data. This confirms that academic research and practitioners should be cautious in relying on Venture Economics data.

Concluding Comments

Our findings strongly suggest that buyout funds have outperformed the public equity markets net of fees over most of our sample period. To invalidate that conclusion, all three reliable commercial data sets would have to be subject to a similar and large positive selection bias despite very different data collection and reporting methods. We view this as highly unlikely. Instead, we view the similar results to indicate that all three databases provide unbiased estimates of the overall performance of PE.

Because PE investments are illiquid, it is perhaps not surprising that they yield investors some premium relative to investing in public markets. As well as the relatively illiquid nature of PE investments, there is also uncertainty regarding how much to commit to PE funds to achieve a target portfolio allocation. This is due to the uncertain time profile of capital calls and realizations. Consequently, “commitment risk” exists when investing in PE. This contrasts with investing in public markets where there is no distinction between capital committed and invested, and trading is continuous. The cost of illiquidity or commitment is likely to vary across investors, and remains an important area for research.