Asia Private Equity Institute (APEI) Private Equity Insights Q2 ?· Private Equity Insights, June 2013…

  • View
    212

  • Download
    0

Embed Size (px)

Transcript

Private Equity Insights, June 2013

Asia Private Equity Institute (APEI), SMU

1

Asia Private Equity Institute (APEI) Private Equity Insights Q2 2013

Contents

An Introduction to the APEI The Value of Human Capital in Private Equity by Melvyn Teo Update on the Institutes Activities

An Introduction to the APEI The vision of the Asia Private Equity Institute is to be the premier research and knowledge hub for private equity and venture capital activities in the Asia Pacific region. According to Preqin, Asia PE funds raised $62 billion in 2011, double the $31 billion raised in 2010. This 100% growth rate was approximately twice that of the global PE fund raising market, and Asia funds have now taken over Europe as the 2nd largest fund-raising market after North America. Despite the surge in interest for private equity in Asia, most academic and practitioner research on private equity remains focused on US and Europe. As the first Asia-focused academic research centre on private equity and venture capital, APEI seeks to fill this knowledge gap. To do so, APEI will be an integrated platform that (i) conducts high quality academic and applied research on private equity and venture capital (ii) educates practitioners and disseminates new ideas and methods, thereby raising the standards and level of professionalism in the industry (iii) elevates the profile of the private equity and venture capital industry in Singapore and Asia. Some of the activities of the institute include a quarterly private equity insights newsletter that parlays academic findings into key lessons for general partners and limited partners, a closed door quarterly investment roundtable which facilitates an exchange of investment ideas between key industry players in an intimate setting, and an annual private equity conference where academics, general partners, limited partners, and industry experts discuss and debate topical issues that resonate with the industry.

Private Equity Insights, June 2013

Asia Private Equity Institute (APEI), SMU

2

The Value of Human Capital in Private Equity Melvyn Teo1 Executive summary We explore the value of human capital in private equity. We find that funds with financial, technical, management, and networking skills outperform funds without such skills. Specifically, funds with top quintile expertise levels deliver IRRs that are 5.4 percent per year greater than do funds with bottom quintile expertise levels. Funds with many experts are also able to generate 50 cents more for every dollar invested and outperform public markets by 31 percent more relative to funds with few experts. Experts are more valuable for buyout, venture capital, and infrastructure than for growth and real estate. Funds that specialize in few industries and funds that are more hands-on in their investment approach tend to benefit more from partner expertise. While a host of skills are relevant in private equity, evidence suggests that strategic management skills are more important than technical expertise and industry knowledge. Finally, large funds are able to ameliorate some of the diseconomies of scale they face by employing more experts. What is the value of human capital in private equity? How important are financial, technical, management, and networking skills in private equity? Given the surfeit of professionals with investment banking and management consulting experience in the industry, clearly financial acumen and strategic management expertise are prized in private equity. But do savvy financial and management skills really translate to better investment performance? If so, what other skills sets are important in private equity? General partners who are managing teams of investment professionals in private equity firms as well as limited partners who are evaluating those teams benefit from knowing the answers to these questions. In this issue of the private equity insight, we measure the impact of expertise on the investment performance of private equity firms by leveraging on multi-dimensional fund level expertise information. By doing so, we also provide insight into how private equity firms add value to their portfolio companies. Our analysis centers on the Preqin private equity performance and cash flow databases. The performance database includes information on fund IRRs and multiples of invested capital while the cash flow database includes monthly capital calls and distributions information for a subset of funds in the performance database. The Preqin database also offers information on fund characteristics such as investment region, vintage, investment type, fund expertise, etc. Preqin obtains its data primarily from public filings by pension funds, from Freedom of Information Act (FOIA) requests to public pension funds, and also voluntarily from GPs and LPs. Therefore, the fund sample is not entirely free of self-selection bias. Nonetheless, Harris, Jenkinson, and Kaplan (2011) argue that the consistency of returns from three distinct datasets: Burgiss, Preqin, and Cambridge Associates, despite very different sample selection criteria, suggests that they are likely to represent reliable measures of private equity performance. Moreover, most of our analysis will focus on differences in the cross-section of fund performance. Therefore, our results are less affected by selection issues unless that there are systematic differences in sample selection across the fund groups that we focus on, e.g., high versus low expertise level funds.

1 Melvyn Teo is Professor of Finance and Co-Director, Asia Private Equity Institute (APEI) at the Singapore Management University. E-mail: melvynteo@smu.edu.sg. Phone: +65-6828-0735.

Private Equity Insights, June 2013

Asia Private Equity Institute (APEI), SMU

3

Our analysis covers private equity funds that invest around the world. There are 4,111 funds in Preqin with performance data as of March 2013. Panel A of Table 1 reports the number, average size, IRR, investment multiple, and public market equivalent (PME) for these funds.2 PME is calculated using the method of Kaplan and Schoar (2005). First, all cash flows from (distributions) and to (capital calls) the fund are discounted using the total realized return of the MSCI World Index from the funds inception to the distribution date as the discount rate.3 The discounted outflows and inflows are then summed to obtain the total discounted outflows and total discounted inflows to the fund. PME is simply the ratio of total discounted outflows to the total discounted inflows and reflects the after fee return to private equity investments relative to public equities.4 As shown in Table 1, the average fund in our sample delivers an IRR of 11.94 per year, generates cash flows that are 1.54 times that of invested capital, and outperforms public equities by about 20 percent. Table 1: Description of data

The database includes self-reported information on whether a fund has financial, technical, industry, operational, management, strategic, marketing, recruiting, and networking expertise. We analyze both the individual expertise score broken down by skill set as well as a fund level aggregate expertise score that measures the total number of different skills that a fund reports. Since there are nine types of skills captured by the expertise information, the fund level aggregate expertise score varies from zero to nine. As reported in Table 1 the average expertise level is 2.90. Also, buyout and venture capital funds tend to have

2 The number and average fund size reported in Table 1 are for funds with IRR information. The number of funds with multiple information is comparable while the number of funds with PME information is significantly lower. 3 Kaplan and Schoar (2005) use the S&P 500 return for the calculation of PME as they investigate US focused funds. 4 Ending NAVs are treated as true values as in Kaplan and Schoar (2005).

Private Equity Insights, June 2013

Asia Private Equity Institute (APEI), SMU

4

the highest expertise levels. In addition, expertise levels appear to have fallen over time. The average expertise level for the pre-1996 vintages of 3.27 dominates the average expertise level for the 2006-2010 vintages of 2.61. General partners investing in the United States, Europe, Asia, and the Middle East and Israel appear to be more skilled than general partners focused on Africa and Latin America. Figure 1: Number of funds with expertise

Figure 2: Distribution of fund expertise levels

Private Equity Insights, June 2013

Asia Private Equity Institute (APEI), SMU

5

Figure 1 graphs the number of funds with expertise. Funds are most likely to report that they have networking skills. The next two most common skill sets are financial and strategic expertise, consistent with the preponderance of general partners with investment banking and management consulting experience in the private equity industry. Technical and marketing skills appear to be less common amongst the funds in our database. Turning to the distribution of fund aggregate expertise levels in Figure 2, we find that there are a large number of funds that do not have any expertise in the nine areas considered. Conditional on reporting at least one type of expertise, funds are most likely to report expertise in five different areas. There are concerns that, for marketing reasons, some funds may attempt to game the system and report that they possess expertise in all nine areas considered. It is comforting to note from Figure 2 that there are very few funds that report having skills sets in all nine areas an