Private equity fund investments: new insights on alignment of interests, governance, returns and forecasting

295 Pages·2015·5.895 MB·English

by  Demaria, Cyril

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Private Equity Fund
Investments
New Insights on Alignment of Interests,
Governance, Returns and Forecasting
Cyril Demaria
© Cyril Demaria 2015
Foreword © Olivier Carcy 2015
Softcover reprint of the hardcover 1st edition 2015 978-1-137-40038-3
All rights reserved. No reproduction, copy or transmission of this
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First published 2015 by
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ISBN 978-1-349-48614-4 ISBN 978-1-137-40039-0 (eBook)
DOI 10.1057/9781137400390
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A catalogue record for this book is available from the British Library.
Library of Congress Cataloging-in-Publication Data
Demaria, Cyril.
Private equity fund investments : new insights on alignment of interests,
governance, returns and forecasting / Cyril Demaria.
pages cm. — (Global financial markets)
ISBN 978-1-349-48614-4
1. Private equity funds. 2. Investments. I. Title.
HG4751.D456 2014
332.63—dc23 2014026511
Contents
List of Figures x
List of Tables xii
Foreword xiv
Olivier Carcy
Acknowledgments xvi
List of Abbreviations and Acronyms xvii
0 Introduction 1
0.1 Problem analysis 2
0 .1.1 L imited partners: irrational investors subject to
biases 3
0 .1.1.1 L imited partners: irrational investors 3
0 .1.1.2 C ontext of investment: intrinsic and
extrinsic factors 7
0 .1.1.3 C urrent regulations (until 2007) 10
0 .1.1.4 N ew regulations (from 2007) 13
0 .1.2 G eneral partners are not subject to effective
corporate governance 13
0.1.3 D eclining marginal returns: the defining moment
of LP-GP relationships 15
0.2 Research objective 1 6
0.3 Methodology 20
0.4 Terminology 21
0 .4.1 Private equity: definition 21
0 .4.1.1 P rivate equity: sectors included 22
0 .4.1.2 P rivate equity: sectors excluded 23
0.4.1.3 P rivate equity funds 25
0 .4.2 L imited partners: definition 28
0 .4.3 L imited partners: categorization and motivations 28
0 .4.3.1 F amily offices and high net worth
individuals 31
0 .4.3.2 F oundations and endowments 37
0 .4.3.3 S overeign wealth funds and governmental
agencies 4 3
0 .4.3.4 F unds-of-funds and gatekeepers 46
0 .4.3.5 P ublic and private pension funds 48
v
vi Contents
0 .4.3.6 I nsurance groups 55
0.4.3.7 B anks 5 6
0 .4.4 G eneral partners: definition 58
0.4.5 C orporate governance: definition 60
0.5 Framework 62
0 .5.1 M arket inefficiencies in private equity 62
0 .5.1.1 G eneral inefficiencies of the financial
markets 6 2
0.5.1.2 I nefficiencies specific to private equity 63
0 .5.2 C orporate governance in private equity 63
0 .5.2.1 M oral hazards in private equity 64
0 .5.2.2 I nformal governance levers in private
equity 6 4
0.5.2.3 F ormal governance levers in private
equity: LPA and other mechanisms 67
0 .5.3 S election of general partners and motivations of
limited partners 100
0 .5.3.1 G eneral partners selection process and
evolution 1 02
0 .5.3.2 G eneral partner selection: agency theory
and critiques 105
0.5.3.3 C onsequences: LPs motivation, GP selection
and portfolio construction 106
0 .5.4 R isks in private equity 111
0 .5.5 L iquidity and time horizon 114
1 Suboptimal Risk–Return Profiles in Private Equity: The Case of
Minority Business Enterprises Investing 117
1.1 Research question 1 20
1.2 Method 124
1.3 Results and discussion 125
1.4 Conclusion and further discussions 1 33
1 .4.1 A necdotal confirmation of the conclusions 133
1 .4.2 E mpirical confrontation of the conclusions, and
rebuttal 134
1.4.3 F urther discussion: investing in underprivileged
markets 137
1.5 Summary and contribution to the research 1 38
2 Fee Levels, Performance and Alignment of Interests in
Private Equity 1 41
2.1 Empirical framework and literature 1 43
2 .1.1 P rivate equity returns: measures 143
2 .1.1.1 A bsolute measures of performances 143
2.1.1.2 R elative measures of performances 144
Contents vii
2 .1.2 P rivate equity risks assumptions 149
2.1.3 L imits of current benchmarking methodologies and
indexes chosen 150
2.2 Data and methodology 1 53
2 .2.1 D rawdowns 154
2 .2.2 D istributions 154
2 .2.3 D ata description 156
2 .2.4 S election of indexes 156
2.2.5 D ata processing and methodology 157
2.3 Analysis and findings 1 63
2 .3.1 A nalysis of the paid-in to committed capital ratios 163
2 .3.2 A nalysis of the management fees and the carried
interest 167
2 .3.2.1 U S VC 1 67
2 .3.2.2 U S LBO 1 72
2 .3.2.3 E MEA VC 1 73
2.3.2.4 E MEA LBO 174
2.3.3 T op-quartile US VC, US LBO, EMEA VC, and EMEA
LBO funds 174
2.3.4 A nalysis of the performances of funds 174
2 .3.4.1 T he carried interest has no material impact
on the relative performance of funds 175
2 .3.4.2 A verage American funds have better IRRs;
indexes better multiples 175
2 .3.4.3 E MEA funds show a very distinct
performance landscape 176
2 .3.4.4 T iming of cash flows can explain part
of the performance of top-quartile fund
managers 177
2.3.4.5 A partial confirmation of performance
cycles in private equity 184
2.4 Conclusion, discussion and limits 1 84
2 .4.1 U se for academic purposes 184
2 .4.2 U se for practitioners 185
2.4.3 L imitations 185
2.5 Summary and contribution to the research 1 86
3 The Predictive Power of the J-Curve 189
3.1 Empirical framework and literature 1 91
3 .2 Data and methodology 1 92
3.2.1 I nterpretation of drawdowns 192
3 .2.2 I nterpretation of distributions 193
3 .2.3 D ata description and cycles identification 193
3.2.4 D ata processing and methodology 198
viii Contents
3.2.4.1 First step: data retrieval 198
3.2.4.2 Second step: sorting data 198
3.2.4.3 Third step: data aggregation in fund categories
(ideal types) and graphical illustration 198
3.2.4.4 Fourth step: determining the potential
predictive power of the J-curve of
performances 199
3.2.4.5 Fifth step: assessment of the reliability of the
J-curves to predict future performances 209
3.3 Analysis and findings 2 09
3 .3.1 A nalysis of the paid-in to committed capital
(PICC) ratios 209
3 .3.2 G raphical analysis of the J-Curves 210
3 .3.3 F irst predictor of performance: the time to
breakeven 215
3 .3.4 I deal-type categories need to be adapted to
each market 215
3 .3.5 R eading graphical representations is insufficient
for tentative performance predictions 216
3 .3.6 C orrelation analysis of the J-Curves 216
3 .3.6.1 U S VC 2 16
3 .3.6.2 U S LBO 2 17
3 .3.6.3 E MEA VC 2 22
3.3.6.4 E MEA LBO 222
3 .3.7 C orrelations first eliminate categories and then
indicate the closest comparable 223
3.3.8 T he predictive power of the J-Curve 223
3.4 Conclusion, discussion and limitations 2 33
3.4.1 U se for academic purposes 234
3 .4.2 U se for practitioners and regulators 235
3 .4.3 L imitations 235
3.4.4 F urther developments 236
3.5 Summary and contribution to the research 2 36
4 General Conclusion 2 38
4.1 Summary 239
4.2 Discussion 240
4 .2.1 C onsequences on extra-financial endeavors in
private equity 240
4 .2.1.1 A ddressing the extra costs associated with
additional extra-financial criteria 241
4 .2.1.2 A ddressing the signaling effect associated
with additional extra-financial criteria 242
4.2.1.3 A ddressing extra risks associated with
additional extra-financial criteria 242
Contents ix
4 .2.2 C onsequences for the treatment of private equity
under solvency and prudential ratios 243
4.2.3 C onsequences on the relationship between
LPs and GPs 246
4.3 Outlook 249
4 .3.1 C onsequences on the communication from GPs 249
4 .3.2 C onsequences on the behavior of LPs 250
4 .3.3 P erspectives for further academic and empirical
research 251
References and Bibliography 253
Index 265