Risk-Adjusted Returns of Private Equity Funds: A New Approach

Arthur G. Korteweg, University of Southern California - Marshall School of Business
Stefan Nagel, University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research; CESifo (Center for Economic Studies and Ifo Institute)

In this paper, the authors introduce a new metric, α, to benchmark the performance of individual private equity funds. The following are excerpts from the research paper:

“Our metric is substantially less sensitive to noise in fund cash flows compared to the popular public market equivalent (PME) and its generalization (GPME), while having the same aggregate pricing implications as GPME. For a large data set of fund cash flows, the standard deviation of α across venture capital funds is 20% lower than (G)PME. For buyout, PME and α are close but deviate in certain subsamples. Using α increases power in regressions involving fund performance and improves performance predictability of future funds.

We use the Burgiss Manager Universe, one of the largest samples of PE fund cash flow histories available, to take the benchmark portfolio approach to the data. Our sample includes a total of 1,219 VC funds and 879 leveraged buyout funds. The data are sourced exclusively from a large number of LPs, avoiding the natural biases introduced by sourcing data from GPs. The data are of very high quality because they are used for control purposes (audit and performance measurement) and cross-checked when multiple LPs invest in the same fund.”