Notes
1 This chapter relies heavily on two papers written by my partner at Greycourt, David Lovejoy, from which I have also borrowed several charts. See Greycourt White Paper No. 40: Private Equity Investing (April 2009), and Greycourt White Paper No. 45: Secondary PE Investing (2011), both available at www.Greycourt.com.
2 And this return disparity is understated as a result of survivorship bias; that is, the worst firms went out of business and their (lousy) returns are no longer included in the database.
3 In Chapter 19, I divide a family investment portfolio into assets that are designed to support current spending, assets that are designed to maintain family wealth over time in the face of inflation, and assets that hold out the possibility of increasing the family's wealth; that is, aspirational assets.
4 See Steven N. Kaplan and Antoinette Schoar, “Private Equity Performance: Returns, Persistence, and Capital Flows,” The Journal of Finance 60, no. 4 (2005): 1791–1823.
5 Fortunately, most PE funds stop earning fees after about 15 years, giving the fund managers a serious incentive to bring the final investments to an end—if necessary, by selling them into the secondary market.
6 Remarkably, many otherwise smart institutions had failed to consider the possibility that distributions from PE funds could stop while capital calls could continue, and that this phenomenon could happen at a time when the public equity markets were down substantially (the so-called “denominator effect”). This created a major liquidity crisis that caused institutional investors to become forced sellers of their limited partnerships into the secondary market.
7 All data is sourced from Thomson Reuters and is as of September 30, 2010. These returns are for all reporting partnerships, so they understate the returns achieved by investors in top-tier funds.
8 However, in the UK, buyouts represent an even larger percentage of GDP than in the United States.
9 Another unhappy factor in the J-curve effect is that fees, including start-up fees, are applied against a smaller asset base (because only a small amount of the total commitment has been called down), making already-high PE fees look even more outrageous. This situation will, however, correct itself in time.
10 In other words, if an institution had a 20 percent target to PE and the value of its liquid portfolio had dropped significantly, the institution found that its exposure to PE was closer to 30 percent.
11 This issue was first brought to my attention by John Barker of Harvard Management Company.