Thursday 1 April 2021

In case you missed it - Spring seminar keynote I

Seminar

For those who were unable to attend, we compiled the key takeaways of the webinar featuring Per Strömberg of the Stockholm School of Economics.  

The webinar provides an overview of private equity (PE) from a limited partner (LP) point of view; Strömberg references data and findings that he gathered in order to inform the Government Pension Fund of Norway. The institutional investor was looking to find potential for value creation beyond existing asset classes. Therefore, they commissioned research to learn more about the potential of PE. 

The first thing to consider is its value proposition. 

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Strömberg: "There is strong evidence that firms become more valuable, profitable and productive under this ownership form. Private equity is active ownership type of investment, which means that through methods of active governance and other methods, PE practitioners try to increase the value of the firms that are being invested in.

This should be good for investors as well. But there is a big caveat because PE firms charge for this service, and the question is whether there is any value left for investors after fees.

There is also evidence that not every general partner (GP) has the same skills as others. Because it’s a competitive market, investors must beware not to pay their whole value-added upfront in terms of acquisition premium when acquiring the asset to begin with.

The question is, if you add value to companies, does it also translate to adding gross value after fees?"

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Strömberg:"Institutions wonder if the market is big enough for them to invest capital? Whether it is or not one thing is clear: investors can commit substantial amounts of capital to it.The market is indulgent – its size depends on how much investment capital there is committed to it.

When limited partners commit capital to PE they are taking on illiquidity risk, and unless the illiquidity premium is high enough to compensate for that, there is no point in doing it. Historically the public market equivalent (PME) has been larger than 1. If you invest in a 10-year holing period (average duration) – there are capital calls and then distributions – there is 20% more capital compared the mimicking strategy which would have instead invested in the S&P 500."

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Strömberg: "Buy-out PE is consistent across periods. With venture capital (VC), the average PME is higher but this is inconsistent across time periods. A lot of the success was seen with funds raised in the mid-late ‘90’s. The spread is also much bigger across the worst performing and best performing funds.

Data is a big issue in PE research because it is a private, opaque asset class and people are not very willing to share data. Using this data we can see patterns according to vintage. 

Quants can become can become easily frustrated with PE research and believe that it is stone-age. This is because we are dealing with illiquid assets, data is poor, time series are short, and on top of that it’s not clear how to measure an alpha if there was one for a private equity fund. The only figures you can trust on performance are cash flows into the funds and returns in the form of distributions. This is why PME has become the benchmark standard."

Access the webinar via: https://vimeo.com/528193071

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