Comments on: Private equity returns are misleading

By: Private Equity Returns Are Misleading (Part II) | Reaction Radio

Private Equity Returns Are Misleading (Part II) | Reaction Radio — Wed, 09 Dec 2009 13:46:24 +0000

[...] seems I’ve ruffled a few feathers with my previous post, Private equity returns are misleading (lots of emails and even a few comments over at Seeking Alpha). The main point of contention is [...]

By: The Private Equiteer

The Private Equiteer — Tue, 08 Dec 2009 23:58:16 +0000

You’re right Alex, and in retrospect, I didn’t outline my points very clearly.

I received a lot of emails regarding this omission, so I’ve made my points a little clearer in a subsequent post. http://www.theprivateequiteer.com/private-equity-returns-are-misleading-part-ii/

I’m still not 100% convinced of my own theory; just putting it out there for debate.

By: Private equity returns are misleading – Part II | A Private Equity Blog

Tue, 08 Dec 2009 23:47:29 +0000

[...] seems I’ve ruffled a few feathers with my previous post, Private equity returns are misleading. The main point of contention is that limited partners (LPs) don’t hold committed capital as [...]

By: Alex

Alex — Tue, 08 Dec 2009 09:01:46 +0000

I was under the impression that no pension fund in their right mind would keep the cash ready from day 1. Rather they would have a portfolio of commitments with differing start and end dates so that the redemptions from one PE fund can be used to meet the cash calls from another. So while you can’t be certain about any particular PE fund’s calls over a particular year you would be much more confident estimating the total across many.

And also you missed out another reason why returns are misleading – the re-investment rate assumption in IRRs. IE if you exit your investment in year 6 the applicability of the quoted return depends on you being able to instantly find equally profitable investments elsewhere with your money.

By: The Private Equiteer

The Private Equiteer — Mon, 07 Dec 2009 23:31:18 +0000

Hi Gordon, great point re restrictions on investing period. We are expected to invest our fund by year fie as you suggested, so I did embellish a little.

I guess my main point was, on a like-for-like basis with other investments, it is unfair to measure returns for a private equity fund just for the period the cash is held by the fund.

Sure many LPs “time” calls to coincide with cash inflows, but that in itself increases the risk of the investment and this additional risk is rarely considered as a risk of the investment itself.

If you really want an apple vs apple comparison, you need to calculate returns using the full committed amount from the day it’s committed, not called.

Just my opinion and certainly questionable.

By: Gordon

Gordon — Mon, 07 Dec 2009 18:49:02 +0000

It is precisely for this reason that LPs ask (and if they don’t, then the GP should try to provide) for cash flow plans. GPs space out investments so as to not ‘freak’out LPs with a huge capital call. There is also a time frame of 15 days to 20 days to meet a capital call – hence if an LP is stretched, they have time to work out options. Giving an LP visibility may also help with the LP-GP relationship.

Some contribution agreements also have a clause which state that an LP is not obligated to commit any capital after the ‘investing’ period which is typically half the fund life. Hence the scenario of making the first call in the 9th year is a little remote.

While the point is well taken that returns to LPs net of fees is lower than returns to the Fund, the extent depends on the distribution waterfall and on the exit timing. The IRR gap varies if the first deal of the fund is a home run, versus the last deal of the fund being a home run.