Briefing for the BVCA research Project:
“Private Equity Fund Level Return Attribution”
The BVCA annual Performance Measurement Survey provides reliable evidence on
the level of returns generated by independent buyout and VC funds in the UK, using
data submitted by 100% of its member firms, which represent the majority of the
players in the UK’s private equity industry. Each year, the survey tells a consistent
story of strong long-term performance on the net of fees basis notwithstanding some
fluctuations in short to medium-term returns. As of 31 Dec 2008, the average since-
inception return of the private equity funds included in the latest survey stands at
16.4% pa and the average 10 year return of these funds is 15.4%.
The double-digit absolute return figures, however, have not been able to dispel the
scepticism of some investors on the ability of private equity to outperform the public
market. Private equity accounts for a relatively small proportion (typically 5%) of
investors’ overall portfolio but requires investors to dedicate considerable time and
resources to selecting managers and tracking performance. Given the high demands
on their ‘governance budget’, it is not surprising that some investors are reluctant to
commit to this asset class without sufficient evidence that private equity generates
significant alpha on the net of fees basis.
It is well-understood that direct comparisons between the money-weighted return of
private equity funds (IRR) and the time-weighted return of public stocks are not
appropriate. Although various methods have been developed to assess the relative
performance of PE funds in a meaningful way, e.g. the Index Comparison Method
often known as PME (Long and Nickels, 1993), few studies have applied these
methods to demonstrate the level of alpha investors can expect from the UK-based
private equity funds. It will be useful to identify the alpha of the private equity funds
relative to a suitable market index and to establish the extent to which the return of
these funds can be attributed to its exposure in a particular sector, deal size and
The surge in the volume of large leveraged buyout deals at the height of the credit
bubble has also led many investors to believe that private equity is no more than
leveraged public equity and any out-performance is generated through financial
engineering. As the era of cheap credit comes to an end, it becomes increasingly
important for the industry to demonstrate that private equity can continue to generate
strong returns, irrespective of the availability of debt. Some deal-level evidence has
been produced recently on the strong out-performance of private equity backed
buyouts after controlling for the effect of leverage and sector exposure (Acharya and
Kehoe, 2008). Such evidence, however, has its limitations in addressing investors’
concerns over private equity’s reliance on leverage. As investors commit their capital
at the fund level, they are more interested in the attributes of fund returns than that of
the gross returns generated by each portfolio company. It would therefore be useful
to further investigate the performance of private equity at the fund level to disentangle
the effect of leverage from the other factors that contribute to fund returns.
Existing literature in this area
Acharya and Kehoe (2008) analyse deal-level data on private equity transactions in
the UK. They un-lever the deal-level equity return and adjust for the un-levered
return to quoted peers to extract a measure of ‘alpha’. They found that alpha is
significant on average and is related to the improvement in operating performance
during the private phase. The findings of the BVCA returns attribution analysis of the
Walker compliant companies are broadly in line with Acharya and Kehoe (2008).
These findings shed positive light on PE performance but are unable to give a clear
indication on the magnitude of alpha net of fees from an investors’ perspective.
A number of studies have also emerged in the recent years in an effort to establish the
performance of private equity funds relative to the public market using methods such
as the profitability index. Some of the studies have gone further to measure the risk
of private equity funds and to produce risk-adjusted returns. These studies have relied
primarily on data from Thomson Venture Economics, which does not have extensive
coverage of the UK-based private equity funds. None of the studies have looked at
the UK market specifically. Nor have they clarified the extent to which the
performance of private equity funds is attributable to the exposure associated with
sector, deal size and stage of the investment, and to the above-sector average level of
leverage employed. A few key studies are covered below.
Kaplan and Schoar (2005, hereafter, KS) find that the performance of the 746 private
equity funds in their sample is close to that of S&P 500, net of fees. The venture
funds perform slightly better than S&P 500 on a value-weighted basis, whilst buyout
funds lags slightly behind the index. Ljungqvist and Richardson (2003, hereafter, LR)
and Phalippou and Gottschalg (2007, hereafter, PG) estimates the beta (the systematic
risk) of private equity funds based on individual investments. This involves matching
the companies in which funds invest with publicly traded companies. The beta of
each portfolio company is assumed to be the same as either the average beta of their
listed industry peers (LR) or the average leverage-adjusted beta of their listed peers
(PG). The weighted average beta of the portfolio company in a fund is then used as a
proxy for the fund beta. Both LR and PG find that private equity funds are on average
riskier than the market portfolio. LR show that the 73 mature US funds in their
sample have an average beta of 1.08 and generated significant outperformance on a
risk-adjusted basis. PG, on the other hand, show an average fund beta of 1.3 after
taking into account of the additional financial risk of the buyout funds in their sample.
They note that risk adjustment led to an underperformance of -6% per annum.
Focus of the study
The BVCA wishes to commission a study, which focuses on identifying and
measuring the key components of fund-level net returns of a representative sample of
UK-based funds, with particular emphasis on the relevant market performance and the
effect of additional leverage.
The sample should comprise both buyout funds and venture funds. It should also
include both funds of older vintages that have been liquidated or have negligible
amount of residual values remaining, and funds of more recent vintages that are yet to
fully realise their returns. The study should be able to shed light on the return
attributes of all sample funds and of each sub sample group as defined by investment
stage and fund vintage.
The researcher(s) may consider adapting the methodology employed in earlier studies
on deal-level return attribution to suit the requirements of the fund-level analysis.
They may also consider approaching the analysis by building on the methodologies
employed by LR and PG. As deal structure data for historic funds are normally
difficult to obtain, the researcher(s) may make reasonable assumptions for the level of
leverage, based on various relevant reports, e.g. the S&P Leveraged Lending Review.
Scenario analysis may be applied to demonstrate the impact on alpha when different
leverage assumptions are made.
A longstanding UK-based fund of funds commits to provide the following
anonymised data items on the UK-based private equity funds captured by its database
(around 100) for the purpose of this project. The fund of funds also commits to share
its industry expertise with and provide support to the researcher(s) to ensure the
successful completion of the project.
At fund level:
fund level cashflows (cash drawdowns for fees, cash drawdowns for investments,
cash or cash-equivalent distributions, residual NAV)
carry and fee percentages.
At portfolio company level:
time of investment
time of exit
limited information on deal structure for a small number of funds
gross cash flows for some of the deals for the majority of the funds1.
Purpose of the study
The primary purpose of the study is to inform the BVCA's strategy for encouraging
investors to commit to PE and VC funds. The BVCA may also disseminate the
results to a broader audience, including members, investors, the media and the
The main limitation is that these gross cash flows were provided to the fund of funds manager during
primary due diligence and not updated thereafter. They are thus most relevant for fully realised deals
at that time. As for the unrealised deals the NAV would change over time.
We are inviting proposals from organisations with in-depth knowledge in the private
equity industry, considerable experience in analysing the performance of private
equity funds and a track record of producing high profile reports. We anticipate that
the project would take 4 to 5 months and we will select the researcher(s) /
organisation(s) that submit the best proposal with a competitive budget. For more
information on how to submit a proposal please download the corresponding ITT
18 Sept ’09 Invitation to tender goes out
09 Oct ‘09 - 17.00 GMT Deadline for submission of proposals
14 Oct ‘09 Notification of preliminary decision
15-16 Oct ‘09 Interviews w/ tenderers
19 Oct ‘09 Notification of final decision
12 Feb ‘10 Submission of 1st draft
5 Mar ‘10 Submission of final draft
Acharya, V. & Kehoe, C. Corporate Governance and Value Creation: Evidence from
Private Equity. SSRN Working Paper Series.
BVCA Annual Report on the Performance of Portfolio Companies, 2008.
BVCA Performance Measurement Survey 2008.
Kaplan, S. & Schoar, A., 2005. Private Equity Performance: Returns, Persistence,
and Capital Flows. Journal of Finance, Vol.60, No.4: 1791-1823.
Ljungqvist, A. & Richardson, M., 2003. The Cash flow, Return, and Risk
Characteristics of Private Equity.’ NBER Working Paper 9454.
Long, A, and Nickels, C., 1993. A Method for Comparing Private Market Internal
Rates of Return to Public Market Index Returns.
Phalippou, L., and Gottschalg, O. 2007. The Performance of Private Equity Funds.
Working paper, University of Amsterdam and HEC Paris.