Private equity has been growing rapidly in recent years, presumably reflecting superior performance? Maybe not. A new study for the European Commission by Oliver Gottschalg from HEC business school in Paris suggests a quite limited improvement in returns, and which is scooped up in management fees. Martin Arnold reports in today's Financial Times: Doubt cast on buy-out firms' huge profits
Based on data from 6,000 private equity deals and about 1,000 buy-out funds, the survey shows that average private equity returns have underperformed the benchmark S&P 500 share index by 3 per cent, after fees charged to investors.
"This does not correspond with the stereotype of the industry making its investors extremely rich," Oliver Gottschlag, who compiled the research, told the Financial Times. "Investors have not had much fun in this asset class, even though they have all been obsessed with gaining access to the best-performing funds."
Excluding fees and carried interest (a widely-used profit sharing scheme), returns from private equity outperformed the S&P 500 by 3 per cent.
"So private equity is generating value somewhere, but its fee structure means the general partners capture double the out-performance they generate," said Mr Gottschlag, who is also head of research at Peracs, an adviser to buy-out investors.
The research was based on data collected from investors in 852 private equity funds raised before 1993, to be sure they had sold all their assets. But Mr Gottschlag said analysis of more recent funds showed their performance had been similar.
In a related piece, Another black mark, Gottschlag explains why reporting of equity returns is misleading:
He argues the internal rate of return (IRR) measure used as a benchmark by most buy-out firms is "misleading" as it exaggerates profits and disguises poor performers.
"Our research shows the way private equity fund performance is most often reported overstates the truth," Mr Gottschlag writes in next month's Harvard Business Review.
The IRR measure assumes that any cash proceeds returned early to investors is reinvested at the IRR rate over the investment period, which risks inflating performance.
Stripping out this inflationary effect - by assuming early cash to investors is invested at a 12 per cent return - Mr Gottschlag said the IRR of the top performing fund in his sample of 1,184 firms fell from 464 per cent to just 31 per cent.
I cannot find the UC paper on the web. But an earlier working paper, Performance of Private Equity Funds, is available online.