Research Handbooks in Financial Law series
Edited by Phoebus Athanassiou
Chapter 4: Private Equity Funds’ Performance, Risk and Selection
Ludovic Phalippou* INTRODUCTION The purpose of this chapter is to assess the risks and returns of private equity funds, based on the different datasets used in the literature and to point out some issues in fund selection. This chapter is divided into two main sections, namely private equity fund risk and return; and private equity fund selection. The first section provides an overview of the academic evidence on the risk and return of investing in private equity funds (buyout and venture capital). We find that the average private equity fund return is comparable or inferior to that of public equity, a finding that is in contrast to what industry associations report. We show that differences in methodology may explain, in part, this paradox. We also find that venture capital funds have market betas of 2.7, whilst buyout funds have lower market betas (1.3). Estimates of cost of capital are around 15 per cent (in excess of risk-free rate) for both buyout and venture capital funds. The second section is dedicated to fund selection. Years of large capital inflows from investors have poorer returns. New evidence on performance persistence is presented, showing that investors may have difficulties exploiting return persistence as this is too short-lived. Finally we report that the most important explanatory variable for the cross-section of buyout returns is the number of investments a private equity firm is holding at the same time. In terms of vocabulary convention, the term ‘(portfolio) company’ shall refer, throughout, to an entity receiving...
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