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

295 Pages·2015·5.895 MB·English
by  DemariaCyril
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Global Financial Markets Global Financial Markets is a series of practical guides to the latest financial market tools, techniques and strategies. Written for practitioners across a range of disciplines it provides comprehensive but practical coverage of key topics in finance covering strategy, markets, financial products, tools and techniques and their implementation. This series will appeal to a broad readership, from new entrants to experienced practitioners across the financial services industry, including areas such as institutional investment; finan- cial derivatives; investment strategy; private banking; risk management; corporate finance and M&A, financial accounting and governance, and many more. Titles include: Erik Banks DARK POOLS, 2nd Edition Off-Exchange Liquidity in an Era of High Frequency, Program and Algorithmic Trading Erik Banks LIQUIDITY RISK Managing Funding and Asset Risk Daniel Capocci THE COMPLETE GUIDE TO HEDGE FUNDS AND HEDGE FUND STRATEGIES Sandy Chen INTEGRATED BANK ANALYSIS AND VALUATION A Practical Guide to the ROIC Methodology Frances Cowell RISK-BASED INVESTMENT MANAGEMENT IN PRACTICE 2nd Edition Jawwad Farid MODELS AT WORK A Practitioner’s Guide to Risk Management Guy Fraser-Sampson INTELLIGENT INVESTING A Guide to the Practical and Behavioural Aspects of Investment Strategy Michael Hünseler CREDIT PORTFOLIO MANAGEMENT A Practitioner’s Guide to the Active Management of Credit Risks Roger Leeds PRIVATE EQUITY INVESTING IN EMERGING MARKETS Opportunities for Value Creation Felix Lessambo THE INTERNATIONAL CORPORATE GOVERNANCE SYSTEM Audit Roles and Board Oversight Ross K. McGill US WITHHOLDING TAX Practical Implications of QI and FATCA David Murphy OTC DERIVATIVES, BILATERAL TRADING AND CENTRAL CLEARING An Introduction to Regulatory Policy, Trading Impact and Systemic Risk Gianluca Oricchio PRIVATE COMPANY VALUATION How Credit Risk Reshaped Equity Markets and Corporate Finance Valuation Tools Andrew Sutherland and Jason Court THE FRONT OFFICE MANUAL The Definitive Guide to Trading, Structuring and Sales Michael C. S. Wong and Wilson F. C. Chan (editors) INVESTING IN ASIAN OFFSHORE CURRENCY MARKETS The Shift from Dollars to Renminbi Global Financial Markets series Series Standing Order ISBN: 978–1–137–32734–5 You can receive future titles in this series as they are published by placing a standing order. Please contact your bookseller or, in case of difficulty, write to us at the address below with your name and address, the title of the series and the ISBN quoted above. Customer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire RG21 6XS, England 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 publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6–10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2015 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries ISBN 978-1-349-48614-4 ISBN 978-1-137-40039-0 (eBook) DOI 10.1057/9781137400390 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. 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

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