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Venture Capital and Private Equity Fund Management, Fund Raising, and Regulation. Cumming & Johan (2013, Chapter 4). 1. Chapter Objectives. Part I: What do institutional investors care about? Who are institutional investors in venture capital and private equity funds, - PowerPoint PPT Presentation
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© Cumming & Johan (2013) Fund Management
Venture Capital and Private Equity Fund Management, Fund Raising, and Regulation
Cumming & Johan (2013, Chapter 4)
1
© Cumming & Johan (2013) Fund Management
Chapter Objectives
• Part I: What do institutional investors care about?– Who are institutional investors in venture capital and private equity funds,– Analyze economic and regulatory considerations factors relevant to VC/PE investment,– Distinguish between fund commitments and draw downs,– Distinguish between direct fund investment, direct company investment and fund-of-
funds investment,– Consider expected rates of return from investment in venture capital and private equity,
• Part II: Fundraising– Empirically consider the effect of regulation of institutional investors and private equity
funds relative to market factors, among other things, on institutional investor capital allocations to private equity funds.
• Part III: Specialized fund mandates– Socially responsible investment mandates in particular,– Empirically compare the importance of an institution’s internal organization structure
versus legal and economic factors driving socially responsible private equity investment.
2
© Cumming & Johan (2013) Fund Management
Chapter 4. Part I
What do institutional investors care about?
3
© Cumming & Johan (2013) Fund Management
Illustrative Data: Dutch Institutional Investment in PE worldwide, 2004
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
DataCapital Commitments vs DrawdownsModes of InvestmentGlobalizationGrowth & Institutional Investor Concerns
Figure 4.3. Current allocation to private equity
Yes29%
No71%
4
© Cumming & Johan (2013) Fund Management
Capital Commitments / Assets
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
DataCapital Commitments vs DrawdownsModes of InvestmentGlobalizationGrowth & Institutional Investor Concerns
5
© Cumming & Johan (2013) Fund Management
Drawdowns, not Commitments – Important re Desired Exposure
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
DataCapital Commitments vs DrawdownsModes of InvestmentGlobalizationGrowth & Institutional Investor Concerns
6
© Cumming & Johan (2013) Fund Management
Modes of Investment
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
DataCapital Commitments vs DrawdownsModes of InvestmentGlobalizationGrowth & Institutional Investor Concerns
Figure 4.6. Current private equity allocation by type of investment
Direct Company Investment20%
Direct Fund Investment40%
Fund of Funds Investment40%
7
© Cumming & Johan (2013) Fund Management
A Global Market
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
DataCapital Commitments vs DrawdownsModes of InvestmentGlobalizationGrowth & Institutional Investor Concerns
Figure 4.7. Current private equity allocation by region of investment
The Netherlands22%
Europe Excluding The Netherlands
46%
U.S.27%
Asia3%
R.o.W.2%
8
© Cumming & Johan (2013) Fund Management
Mode of Investment Depends on Internationalization
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
DataCapital Commitments vs DrawdownsModes of InvestmentGlobalizationGrowth & Institutional Investor Concerns
9
Figure 4.8. Country breakdown by type of investment
31%
9%6%
0% 0%
40%
44%
36%
50%
53%
28%
48%
58%
50%
47%
0%
10%
20%
30%
40%
50%
60%
70%
The Netherlands Europe Excluding TheNetherlands
U.S. Asia R.o.W.
Direct company investments
Direct fund investments
Fund of funds investments
© Cumming & Johan (2013) Fund Management
Growth in PE Investment
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
DataCapital Commitments vs DrawdownsModes of InvestmentGlobalizationGrowth & Institutional Investor Concerns
Figure 4.9. Future allocation to private equity (planned for 2006-2010)
No65%
Yes35%
10
© Cumming & Johan (2013) Fund Management
What Institutional Investors Care About
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
DataCapital Commitments vs DrawdownsModes of InvestmentGlobalizationGrowth & Institutional Investor Concerns
Figure 4.10. Attractiveness of private equity segments within 2006-2010
1.4
2.0
2.2
3.3
3.5
3.5
3.9
4.1
1 2 3 4 5
Others
Non-financial objectives
Corporate objectives
Risk diversification
Reaching a yearly positive return over the entireperiod of the commitment
Balanced portfolio (looking at correlation ofprivate equity to other asset classes)
Increase of the relative return
Portfolio diversification
Unimportant Important
11
© Cumming & Johan (2013) Fund Management
Return Expectations
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
Targeted ReturnsAbsolute Return ExpectationsRelative Return ExpectationsReturn BenchmarksPerformance Figures
Table 4.1. Targeted Absolute and Relative Returns, 2006 – 2010
In the case of a targeted absolute return, which absolute return is your
institution/group seeking to generate from private equity investments
In the case of a targeted relative rate of return, what level of over return (in basis points) is
your institution/group expecting from private equity in comparison to public equity
investments
Average 10 315
Median 10 300
Minimum 5 100
Maximum 20 1000
12
© Cumming & Johan (2013) Fund Management
Absolute Return Expectations
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
Targeted ReturnsAbsolute Return ExpectationsRelative Return ExpectationsReturn BenchmarksPerformance Figures
Figure 4.11. Absolute return sought from private equity investments
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
4 6 8 10 12 14 16 18 20
Targeted Absolute Return %
Per
cen
tag
e o
f R
esp
ond
en
ts
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© Cumming & Johan (2013) Fund Management
Relative Return Expectations
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
Targeted ReturnsAbsolute Return ExpectationsRelative Return ExpectationsReturn BenchmarksPerformance Figures
Figure 4.12. Targeted relative rate of return:private equity net of public equity returns (in basis points)
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
100 200 300 400 500 600 700 800 900 1000
Expected Private Equity Returns - Expected Public Equity Returns (in Basis Points)
Per
cen
tag
e o
f R
esp
ond
en
ts
14
© Cumming & Johan (2013) Fund Management
Return Benchmarks
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
Targeted ReturnsAbsolute Return ExpectationsRelative Return ExpectationsReturn BenchmarksPerformance Figures
Figure 4.13. Private equity benchmarks
0%
0%
0%
4%
7%
7%
9%
15%
24%
33%
0% 5% 10% 15% 20% 25% 30% 35%
FTSE All Shares
Hang Seng Index
Nikkei Index
AEX (Euronext Amsterdam)
S&P 500
Internal industry Rating by FundManager
Euro Stoxx
Others
MSCI World
Thompson Financial / VentureEconomics Benchmark Reports
15
© Cumming & Johan (2013) Fund Management
Regulation Matters - US Experience
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
US ExperienceDutch Experience
4.16. Capital Gains Taxes and Fundraising in the US (Source: Poterba, 1989a,b)
0
1000
2000
3000
4000
5000
6000
1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985
VC
Fu
nd
rais
ing
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
Cap
ita
l Ga
ins
Ta
x R
ate
VC Fundraising ($US m) Capital Gains Tax Rate
16
© Cumming & Johan (2013) Fund Management
Regulation Matters - Dutch Experience
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
US ExperienceDutch Experience
Figure 4.15. Important changes in the Dutch legal and regulatory environment for private equity investment strategy
1.1
2.0
2.2
2.7
3.4
1 2 3 4 5
Others
Reform of Dutch bankruptcy laws in theperiod from 1997 to 1999
Implementation of Basel II
The new International FinancialReporting Standards (IFRS)
The proposed new "FinancieelToetsingkader" (FTK) in 2006 by the
Pensioen & Verzekeringskamer
Unimportant Important
17
© Cumming & Johan (2013) Fund Management
Institutional Investor Experience
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
Institutional Investor ExperienceInvestment CriteriaRisks / HurdlesOpportunitiesPerformance
Figure 4.17. Experience among managers specifically assigned responsibility for private equity
0.6
2.9
3.0
4.8
10.9
0 2 4 6 8 10 12
Department head's average number ofprivate equity exits
Department head's average yearsoperational industry experience
Average number of personsresponsible for private equity
Department head's average yearsrelevant private equity industry
experience
Department head's average yearsexperience in banking, insurance or
investment management
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© Cumming & Johan (2013) Fund Management
Direct PE Fund Investment Criteria
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
Institutional Investor ExperienceInvestment CriteriaRisks / HurdlesOpportunitiesPerformance
Figure 4.18. Important selection criteria for direct investments in private equity funds
1.5
2.3
2.6
2.8
3.0
3.5
3.6
3.6
3.7
3.8
4.0
4.1
4.1
4.1
4.1
4.2
4.4
1 2 3 4 5
Others
Possibility of using fund manager as sparring partner for own program
Image and degree of recognition of the fund
Offering of customized products
Quality of co-investors
Fulfillment of corporate governance requirements by the fund manager
Team breadth (number of professional)
Transparency in selection process of portfolio companies
Operating value-added
Reporting quality
Industry know how of management
Financial experience of management
terms of investment
Fund track record
Fee structure
Operational experience of management
Fund manager track record
Unimportant Important
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© Cumming & Johan (2013) Fund Management
Fund-of-Funds Investment Criteria
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
Institutional Investor ExperienceInvestment CriteriaRisks / HurdlesOpportunitiesPerformance
Figure 4.19. Important selection criteria for investments in fund of funds
1.3
3.0
3.2
3.2
3.3
3.8
3.8
4.0
4.0
4.1
4.1
4.2
4.3
4.3
4.4
4.5
1 2 3 4 5
Others
Possibility of using the fund of funds manager as sparring partner for own program
Quality of co-investors in fund of funds
Image and degree of recognition of the fund of funds
Offering of customized products
Fulfillment of corporate governance requirements by the fund manager
Financial experience of management
Operational experience of management
Reporting quality
Industry know how of management
Terms of investment
Transparency in selection process of funds/fund managers
Fund of funds manager track record
fee structure
Fund of funds track record
Existing network and access to exclusive, top-quartile funds
Unimportant Important
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© Cumming & Johan (2013) Fund Management
Perceived Risks / Hurdles
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
Institutional Investor ExperienceInvestment CriteriaRisks / HurdlesOpportunitiesPerformance
Figure 4.20. Risks and hurdles associated with private equity investment
1.2
3.1
3.2
3.2
3.3
3.4
3.4
3.5
3.7
3.7
3.7
1 2 3 4 5
Others
Reporting and corporate governance
Effort to convince internal committees (e.g., board of directors)
Long-term commitment
Management time and resource consumption
Legal and contractual issues
Governance (monitoring and managing) costs compared to other assetsEffortto convinve internal committees (e.g., board of directors)
Lack of own know-how
Risk of default
Lack of performance transparency
Illiquidity
Unimportant Important
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© Cumming & Johan (2013) Fund Management
What to do to mitigate risks?
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
Institutional Investor ExperienceInvestment CriteriaRisks / HurdlesOpportunitiesPerformance
Figure 4.21. Important approaches to reduce the risk of private equity investment
1.2
2.8
3.2
3.3
3.4
3.4
3.6
3.7
4.0
1 2 3 4 5
Others
Working together with advisors
Development of internal know how
Diversification through differentfinancing stages (VC, Buyout)
Diversification through internationalinvestments
Diversification through investment infunds of funds
Diversification through differentindustries
Diversification through investments infunds
Diversification through the number ofinvestments
Unimportant Important
22
© Cumming & Johan (2013) Fund Management
Perceived Investment Opportunities
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
Institutional Investor ExperienceInvestment CriteriaRisks / HurdlesOpportunitiesPerformance
Figure 4.22. Attractiveness of different private equity segments within 2006-2010
1.1
2.5
2.5
2.5
2.6
2.6
2.7
2.7
2.7
2.7
2.8
3.1
1 2 3 4 5
Others
Sustainable/Socially and EnvironmentalResponsible Private Equity
Dutch Venture Capital Investments
Asian Venture Capital Investments
Asian Development/Growth/BuyoutInvestments
Acquisition of Secondary Positions
U.S. venture capital investmebts
Investments in Emerging Markets
U.S. Development/Growth/BuyoutInvestments
Dutch Development/Growth/BuyoutInvestments
European Venture Capital Investments
European Development/Growth/BuyoutInvestments
23
© Cumming & Johan (2013) Fund Management
Summary
Sources of FundsReturn Expectations
Regulation MattersRisk, Return, Performance Statistics
• Managing a PE fund: need to consider what institutional investors care about
• Global market– Regions– Direct company, direct fund versus fund of funds
• Perceived risks, returns• Regulatory environment• Hurdles and strategies to overcome hurdles
24
© Cumming & Johan (2013) Fund Management
Chapter 4. Part II
Fundraising: Economic and Institutional Effects
25
© Cumming & Johan (2013) Fund Management
Motivation
• 2003 CALPERS disclosure lawsuit
• Public pension funds must disclose venture capital and private equity returns, even on unexited investments
• Implications for understanding determinants of, and reporting of, returns
26
© Cumming & Johan (2013) Fund Management
Objectives
• Examine institutional investor behavior in response to a dearth of private equity regulations
• Examine role of reporting standards (IFRS, as well as FTK and Basel II) in shaping institutional investor attitudes towards private equity
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© Cumming & Johan (2013) Fund Management
InstitutionalInvestor 1
Venture Capital Funds
Entrepreneurial Firms
Fundraising Returns
Supply ofInvestments
Demand forInvestments
Intermediation Issues for Fundraising
Different Types:-Pension-Insurance-Bank
And DifferentCountries
PensionPlanMembers(you and I)
Regulated(FTK, IFRS,BASEL II)(helps differenttypes & fromdifferent regions)
ScantlyRegulated(e.g., noreportingstandards)(discouragesinstitutionalinvestors)
Institutional Investor 2
28
© Cumming & Johan (2013) Fund Management
Venture Capital and Private Equity Regulation
1. No strict standards for valuing investments in unexited companies
2. Recent international developments [indirectly] relevant for private equity investments:
a. International Financial Reporting Standards (“IFRS”)(regulation of reporting standards and transparency)
b. Financieel Toetsingkader (“FTK”)(regulation of portfolio management standards such as of matching assets and liabilities)(analogous to Prudent Man Standards Rule for Pension Funds in US (ERISA 1979), which greatly stimulated US PE investment)
c. Basel II(regulation of risk management and disclosure standards)
29
© Cumming & Johan (2013) Fund Management
Research Questions
1. Does a lack of transparency in private equity disclosures inhibit institutional investors from investing in private equity?
2. Have the IFRS, FTK and Basel II facilitateda. Investment in private equity?b. International private equity investment?c. The type of private equity investment (direct company,
direct fund, fund or fund)?
30
© Cumming & Johan (2013) Fund Management
Main Findings
• A comparative dearth of regulations, particularly in regards to reporting, inhibits investment in private equity
– This effect is large: if institutional investors were 20% more confident in private equity with better regulations, then they would contribute an extra 1% of their total assets (to 2.44% from a current average of 1.44%) to private equity
• IFRS, FTK and Basel II have partly facilitated institutional investor confidence in private equity, and stimulated international investment in private equity
– This effect is also statistically and economically significant (details to follow…!)
31
© Cumming & Johan (2013) Fund Management
Data
DataEmpirical Tests
Conclusions
Sponsors for hand collecting data:AEI Brookings / Sciences PoAdveq
32
© Cumming & Johan (2013) Fund Management
Data
DataEmpirical Tests
Conclusions
• As discussed in Part I above, 100 participating Dutch institutions (approximately 10% of all Dutch institutional investors)
• Extremely detailed data on their allocations to private equity, as well as other asset classes
• Information in regards to their view on a dearth of private equity regulations, and the IFRS, FTK and Basel II
33
© Cumming & Johan (2013) Fund Management
Table 4.3.Panel A. Characteristics of the Institutional Investors in the Dataset
Type of Financial Institution
Number of Institutions in
the dataset
Average Assets
(millions of
Euros)
Average Targeted
Absolute Rate of Return for
Private Equity Investments (%) (as at 2005) for
institutions that will invest
in private equity ’06-10
Average Targeted Relative Rate of Return
for Private Equity Investments Relative to
Public Equity (basis points) (as at 2005) for
institutions that will invest in private equity
2006-2010
Pension Fund 56€
2,942.86 10.35 286.11
Insurance Company 25€
5,008.00 8.14 287.50
Bank / Financial Services 19€
9,752.63 13.17 440.00
All Types of Institutional Investors 100
€ 4,753.00 10.40 314.81
34
© Cumming & Johan (2013) Fund Management
Table 4.3. (Continued)Panel B. Asset Allocations (Percentage of Assets Invested in Different Asset Classes)
...Current (as at 2005)
Type of Financial Institution
Publicly Traded Equities Bonds
Cash / Currencie
sIndex Funds
Private Equity
Other Types of
Alternative Investments
Other
Pension Fund 33.38 50.89 4.32 1.60 1.17 7.43 1.21
Insurance Company 23.80 55.72 9.56 0.48 0.73 6.23 3.48
Bank / Financial Services 27.32 48.43 5.11 0.58 1.36 16.05 1.16
All Types of Institutional Investors 29.83 51.63 5.78 1.13 1.09 8.77 1.77
…Planned (for the period 2006-2010)
Type of Financial Institution
Publicly Traded Equities Bonds
Cash / Curren
cies
Index Fund
sPrivate Equity
Other Types of Alternative Investments
Other
Pension Fund 31.51 51.73 2.86 1.97 1.67 9.53 0.73
Insurance Company 24.71 59.02 2.52 2.16 0.62 8.37 2.60
Bank / Financial Services 24.95 47.59 2.68 1.05 1.86 21.34 0.53
All Types of Institutional Investors 28.56 52.77 2.74 1.85 1.44 11.48 1.16
35
© Cumming & Johan (2013) Fund Management
Table 4.3 (Continued) Panel C. Private Equity Investments
...Current (as at 2005)
Type of Financial Institution
Number of Institutions Investing in Private
Equity (All Regions)
Percentage of Private
Equity Investments in The
Netherlands
Percentage of Private
Equity Investment
s in Europe outside
The Netherland
s
Percentage of Private
Equity Investmen
ts in the U.S.
Percentage of
Private Equity
Investments in Asia
Percentage of Private
Equity Investment
s in Rest of World
Percentage of Direct Company
Investments
Percentage of Direct
Fund Investmen
ts
Percentage of Fund of Fund
Investments
Pension Fund 14 23.00 43.43 25.71 4.86 3.00 8.57 41.86 49.57
Insurance Company 7 26.71 49.43 23.86 0.00 0.00 23.57 52.86 23.57
Bank / Financial Services 8 13.38 44.75 28.13 0.63 0.63 36.88 19.00 31.63
All Types of Institutional Investors 29 21.24 45.24 25.93 2.52 1.62 20.00 38.21 38.34
…Planned (for the period 2006-2010)
Type of Financial Institution
Number of Institutions Investing in Private
Equity (All Regions)
Percentage of Private
Equity Investments in The
Netherlands
Percentage of Private
Equity Investment
s in Europe outside
The Netherland
s
Percentage of Private
Equity Investmen
ts in the U.S.
Percentage of
Private Equity
Investments in Asia
Percentage of Private
Equity Investment
s in Rest of World
Percentage of Direct Company
Investments
Percentage of Direct
Fund Investmen
ts
Percentage of Fund of Fund
Investments
Pension Fund 19 13.00 52.42 28.58 3.21 2.79 6.32 36.58 57.11
Insurance Company 8 35.00 40.00 23.75 1.25 0.00 32.25 31.50 36.25
Bank / Financial Services 8 10.63 40.63 35.00 0.63 0.63 31.88 23.13 32.50
All Types of Institutional Investors 35 17.49 46.89 28.94 2.17 1.66 18.09 32.34 46.71
36
© Cumming & Johan (2013) Fund Management
DataEmpirical Tests
Conclusions
Empirical Tests
37
© Cumming & Johan (2013) Fund Management
Comparison of Means and Medians
DataEmpirical Tests
Conclusions
• Greater private equity investment where:
Lower rank on importance of dearth of PE regulations
High rank on importance of IFRS, FTK and Basel II
Higher assets, higher PE return expectations
38
© Cumming & Johan (2013) Fund Management
Table 4.5. Difference of Means and Medians Tests
Planning on Investing in Private Equity in 2006 - 2010
Not Planning on Investing in Private Equity in 2006 -
2010 Difference of Means
Test
Difference of Medians
TestNumber
of Observati
ons
Mean Median
Number of
Observations
MeanMedia
n
Assets (million Euros) 35 10114 2000 65 1866 500 3.70***p <=
0.000***
Rank of Importance of Dearth of Legal Restrictions
35 2.77 3 65 3.02 3 -1.55p <=
0.014**
FTK (2006) 35 3.40 4 65 2.17 2 5.77***p <=
0.003***
IFRS (2005) 35 2.71 3 65 1.97 2 3.68*** p <= 0.546
Basel II (2004) 35 2.20 2 65 1.25 1 4.58***p <=
0.008***
Expected Return on Private Equity in Excess of Public Equity (Basis Points)
35 252.57 250 65 48.62 50 5.91***p <=
0.000***
39
© Cumming & Johan (2013) Fund Management
Econometric Tests
DataEmpirical Tests
Conclusions
• Logit models of likelihood of PE investment
• OLS models of extent of PE investment (relative to other asset classes)
• OLS models of PE investment in different regions (Netherlands, Europe, US and Asia)
• Various robustness checks
40
© Cumming & Johan (2013) Fund Management
Table 4.7 Panel A
(see chapter for others)
Model (1) Model (2)
For Models (3) – (5), the LHS percentage variable is transformed as ln (Y/(1-Y))
Model (3) Model (4) Model (5)
Logit Probability of PE Allocation in 2006 – 2010
Logit Probability of PE Allocation in 2006 – 2010
OLS of % PE Allocation in 2006 – 2010
OLS of % PE Allocation in 2006 – 2010
OLS of % PE Allocation in 2006 – 2010 for subsample
that was in PE in 2005 and/or will allocate to PE in 2006-
2010
Marginal Effect t-statistic
Marginal Effect t-statistic Coefficient t-statistic
Coefficient t-statistic Coefficient t-statistic
Constant -2.468 -3.483*** -0.897 -2.564** -5.914 -11.766*** -5.759 -11.524*** -3.731 -5.594***
Log (Assets) 0.199 3.231*** 0.088 1.794* 0.132 2.414** 0.121 2.442** 0.026 0.409
Log (Excess Expected Return on PE)
0.058 1.732* 0.100 2.806*** 0.029 1.991** 0.022 1.428 -0.020 -0.429
Pension Fund 0.513 2.921*** 0.136 0.992 0.472 2.660*** 0.293 1.306 0.755 3.120***
Insurance Company 0.378 1.281 0.099 0.556 0.065 0.364 -0.057 -0.275 -0.295 -1.061
Degree of Importance of Dearth of Regulations in PE
-0.323 -2.597*** -0.216 -1.787* -0.260 -1.885*
Dearth of Regulations Relative Rank
-0.014 -0.854 -0.019 -0.913
FTK 0.199 2.108** 0.214 2.616*** 0.222 2.257**
FTK Relative Rank 0.059 2.730*** 0.106 5.956***
IFRS 0.046 0.466 0.089 1.109 -0.031 -0.355
Basel II 0.370 2.601*** 0.246 2.587*** 0.152 1.333
Pseudo R2 (Adjusted R2 for Models (3) - (5))
0.605 0.547 0.469 0.471 0.248
41
© Cumming & Johan (2013) Fund Management
DataEmpirical Tests
Conclusions
Conclusions(Part II)
42
© Cumming & Johan (2013) Fund Management
Comparative Dearth of PE Regulations
DataEmpirical Tests
Conclusions
• A comparative dearth of regulations, particularly in regards to reporting, inhibits investment in private equity
– This effect is large: – 20% more confident in private equity with better regulations,
contribute an extra 1% of their total assets (to 2.44% from a current average of 1.44%) to private equity
43
© Cumming & Johan (2013) Fund Management
IFRS, FTK and Basel II
DataEmpirical Tests
Conclusions
• IFRS, FTK and Basel II have stimulated Private Equity investment
• An increase in rank of importance of these factors by 20% affects:– Investment in PE:
• Increases the probability of private equity investment by 16%• Increases the amount invested by up to 1% of total assets
– International investment in PE:• Increases international PE investment by 0.8% of institutions’ assets
– Mode of PE Investment:• Reduces direct fund investments by up to 0.8% of institutions’ assets• Increases fund-of-fund investments by up to 0.6% of institutions’ assets
44
© Cumming & Johan (2013) Fund Management
Chapter 4. Part III
Specialized Fund Mandates: SRI
45
© Cumming & Johan (2013) Fund Management
Motivation
• Increasing practitioner and academic attention on:– Socially Responsible Investment (SRI)– Corporate Social Responsibility (CSR)
• Studies of SRI and CSR have focused on publicly traded companies
• Publicly traded companies start as privately held firms!
46
© Cumming & Johan (2013) Fund Management
InstitutionalInvestor 1
Venture Capital Funds
Entrepreneurial Firms
Fundraising Returns
Supply ofInvestments
Demand forInvestments
Venture Capital Intermediation
Different Types:-Pension-Insurance-Bank
And DifferentCountries
PensionPlanMembers(you and I)
Regulated(e.g., IFRS)
ScantlyRegulated(e.g., noreportingstandards)(discouragesinstitutionalinvestors)
Institutional Investor 2
47
© Cumming & Johan (2013) Fund Management
Questions
1. When do institutional investors make SRI investments into PE/VC funds?
2. Does SRI in VC/PE depend ona. Internationalization?b. Legal and reporting standards?c. Institutional and organizational structures?
3. Does the determinants of SRI for VC/PE differ relative to other institutional investments?
48
© Cumming & Johan (2013) Fund Management
New Data… New Insights
• First direct look at institutional investor SRI investments in venture capital and private equity
• New generalizable results as to when SRI takes place for a variety of asset classes
49
© Cumming & Johan (2013) Fund Management
Main Findings
• SRI in VC/PE for institutional investors that have:
– International investment focus
– Adhere to the International Financial Reporting Standards (IFRS)
– Individuals that work for the institutional investor do not compete for returns (i.e., the decision to implement SRI is centralized)
– Direct investments (not fund-of-fund investments)
• Similar determinants of SRI for VC/PE as for other asset classes
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Data
Data
Empirics
Conclusions
Sponsors for hand collecting data:AEI Brookings / Sciences Po
Adveq
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Figure 7.1. Socially Responsible Investment (SRI) Programs for Private Equity and Other Asset Classes among 100 Dutch Institutional Investors
0
5
10
15
20
25
30
SRI (2005) SRI (Planned New Programs 2006-2010)
Nu
mb
er o
f In
stit
uti
on
s
SRI Excluding Private Equity SRI for Private Equity
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Pension FundInsuranceCompany Bank / Financial
Services All Types ofInstitutionalInvestors
SRI Private Equity
SRI (All)
Total Sample
0
10
20
30
40
50
60
70
80
90
100N
umbe
r of
Inst
itutio
ns
Figure 7.2. Socially Responsible Investment (SRI) Programs by Type of Institution(Current as at 2005 or Planned for 2006-2010)
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Data
Empirics
Conclusions
Empirical Tests
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Comparison of Means and Medians
Data
Empirics
Conclusions
• SRI in VC/PE for institutional investors that have:
– International investment focus
– Adhere to the International Financial Reporting Standards (IFRS)
– Individuals that work for the institutional investor do not compete for returns (i.e., the decision to implement SRI is centralized)
– Direct investments (not fund-of-fund investments)
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Difference of Means, Proportions and Medians Tests for SRI
Socially Responsible Private Equity Investment Program (current at 2005 or
planned for 2006 – 2010)
No Socially Responsible Private Equity Investment Program (current at 2005 or
planned for 2006 – 2010) Difference of Means Test
Difference of Medians Test (or
Difference of Proportions Test
for Dummy Variables)
Number of Observations
Mean MedianNumber of
ObservationsMean Median
The Netherlands Domestic Private Equity Investment 19 0.34 0.00 81 0.2353 0.00 0.52 p <= 0.146
European (outside The Netherlands) Private Equity Investment 19 2.39 1.88 81 0.30 0.00 3.55*** p <= 0.000***
US Private Equity Investment 19 1.67 1.13 81 0.12 0.00 3.98*** p <= 0.000***
Asia Private Equity Investment 19 0.16 0.00 81 0.03 0.00 1.92* p <= 0.213
Fund of Funds Private Equity Investment 19 1.35 0.88 81 0.45 0.00 2.35** p <= 0.000***
International Financial Reporting Standards 19 2.63 3.00 81 2.14 2.00 1.89* p <= 0.677
Rank of Attractiveness of Returns to Sustainable Investment 19 2.89 3.00 81 2.40 3.00 1.76* p <= 0.171
Chief Investment Officer Responsibility 19 0.32 0.00 81 0.02 0.00 2.62** 4.21***
Log (Assets) 19 12336.84 6500.00 81 2974.07 800.00 3.10*** p <= 0.001***
Pension Fund 19 0.47 1.00 81 0.58 1.00 -0.82 -0.84
Insurance Company 19 0.32 0.00 81 0.23 0.00 0.72 0.77
Bank 19 0.21 0.00 81 0.19 0.00 0.24 0.2556
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Econometric Tests
Data
Empirics
Conclusions
• Logit models of likelihood of SRI PE investment
• OLS and Heckman-corrected models of extent of SRI PE investment
• Full sample and subsample invested in PE
• Consider differences for SRI in other asset classes
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Table 4.8. Logit Regression Analyses for Sustainable / Socially Responsible Private Equity Investment
Panel A. Full Sample of 100 Dutch Institutions
Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
Marginal Effect
t-statisticMarginal
Effectt-
statistic
Marginal
Effect
t-statistic
Marginal
Effect
t-statistic
Marginal Effect
t-statistic
Marginal
Effectt-statistic
Constant -0.966 -4.144*** -0.824-
2.821***
-0.741-
2.626***
-0.969-
4.083***
-0.794-
2.421**-0.661 -2.868***
The Netherlands Domestic Private Equity Investment
0.015 0.632
European (outside The Netherlands) Private Equity Investment
0.111 2.180** 0.075 1.710* 0.040 1.818*
US Private Equity Investment 0.262 1.549
Asia Private Equity Investment 0.145 0.998
Fund of Funds Private Equity Investment -0.014 -0.577 -0.069 -1.685* -0.095 -1.303 -0.025 -0.788 -0.042 -1.302 -0.028 -1.322
International Financial Reporting Standards
0.015 0.386 -0.006 -0.172 0.021 0.475 0.034 0.823 0.005 0.178 0.027 1.117
Rank of Attractiveness of Returns to Sustainable Investment
0.046 1.875* 0.020 1.096
Chief Investment Officer Responsibility 0.496 2.044** 0.661 2.423** 0.621 2.190** 0.459 1.893* 0.512 1.414 0.096 0.817
Log (Assets) 0.085 3.454*** 0.0692.591**
*0.049 1.692* 0.080
3.356***
0.056 2.164** 0.044 2.464**
Pension Fund 0.137 1.376 0.130 1.167 0.072 0.590 0.136 1.361 0.097 1.086 0.101 1.348
Insurance Company 0.110 0.798 0.201 1.041 0.173 0.992 0.107 0.793 0.154 0.887 0.088 0.818
Number of Observations 100 100 100 100 100 100
Number Observations where Dependent Variable = 1
19 19 19 19 19 14
Adjusted R2 (pseudo R2 for Model 1) 0.314 0.541 0.530 0.323 0.596 0.393
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Table 4.8 (Continued)Panel B. Subsample of Private Equity Investments (Models (7) - (10)) and Bivatiate Logit Estimates with Sample Selection (Model (11))
Model (7)Subsample of Institutions
in Private Equity
Model (8)Subsample of Institutions in Private Equity
Model (9)Subsample of Institutions in Private Equity
Model (10)Subsample of Institutions in Private Equity
Model (11)
Step 1: Probability of Investment in Private Equity
Step 2: Probability of Socially Responsible
Private Equity
Marginal Effect t-statistic
Marginal
Effect t-statistic
Marginal
Effectt-
statistic
Marginal
Effectt-
statistic
Marginal
Effectt-
statistic
Marginal
Effect t-statistic
Constant -0.716 -1.155 -2.477 -2.207** -1.349 -1.376 -2.173-
2.103**-3.490
-3.315**
*-4.451 -2.786***
The Netherlands Domestic Investment -0.025 -0.339
European (outside The Netherlands) Investment 0.204 1.764* 0.274 2.039**
US Investment 0.574 2.227**
Asia Investment 0.217 0.680
Fund of Funds Investment -0.113 -1.481 -0.188 -1.950* -0.271-
1.983**-0.173 -1.574
International Financial Reporting Standards -0.088 -0.711 -0.063 -0.392 0.002 0.016 0.011 0.067 -0.380 -1.622
Rank of Attractiveness of Returns to Sustainable Investment
0.375 1.851* 0.207 1.621 0.245 1.837* 0.237 1.955*
Attractiveness of Returns to Private Equity versus Public Equity
0.0133.506**
*
Chief Investment Officer Responsibility 0.470 2.506** 0.404 2.125** 0.450 1.983** 0.700 1.448
Log (Assets) 0.122 1.566 0.211 2.018** 0.060 0.567 0.188 1.944* 0.243 1.587 0.290 2.883***
Pension Fund 0.151 0.528 0.324 0.962 0.037 0.110 0.279 0.920
Insurance Company 0.159 0.579 0.289 1.064 0.194 0.862 0.083 0.256
Number of Observations 35 35 35 35 100 35
Adjusted R2 (pseudo R2 for Model 1) 0.193 0.406 0.440 0.296
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Economic Significance (1)International Investment Focus
Data
Empirics
Conclusions
• Socially responsible investment is approximately 1-2% more common among institutional investors with a 10% greater international investment focus in Europe outside The Netherlands
• Socially responsible private equity investment is approximately 5-6% more common among institutional investors with a 10% greater international investment focus in the United States
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Economic Significance (2) IFRS
Data
Empirics
Conclusions
• An increase in the ranking of the importance of the International Financial Reporting Standards (IFRS) by 1 (on a scale 1 – 5, where 5 is the most important) increases the likelihood that an institutional investor will adopt a socially responsible investment program by about 1.1%
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Economic Significance (3) Chief Investment Officer
Data
Empirics
Conclusions
• When a CIO is in charge, a socially responsible private equity investment program is approximately 40-50% more likely to be adopted
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Economic Significance (4) Control Variables
Data
Empirics
Conclusions
• An increase in the rank of the relative returns to socially responsible investments by 1 (on a scale of 1 to 5, where 1 is the lowest) increases the probability of a socially responsible investment by 1-3%.
• No statistically significant differences in the propensity to carry out socially responsible investments depending on the type of investor (pension fund, insurance company or bank / financial institution), but larger institutions are more likely to do SRI
• Socially responsible investment is approximately 1-3% less common among institutional investors that invest a 10% greater proportion in fund-of-funds
• Similar findings for non-SRI PE investments (next slide)
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Logit Regression Analyses for Sustainable / Socially Responsible Investment For Non PE Investment
Model (12) Model (13) Model (14) Model (15) Model (16) Model (17)
Marginal Effect
t-statistic
Marginal Effect
t-statistic
Marginal
Effectt-
statisticMarginal
Effectt-
statistic
Marginal
Effectt-
statisticMarginal
Effect t-statistic
Constant -0.819-
2.280**-0.840
-2.142**
-0.622 -1.451 -0.871-
2.361**-1.185
-2.755**
*-1.029 -3.014***
The Netherlands Domestic Investment -0.021 -0.373
European (outside The Netherlands) Investment
0.156 1.975** 0.144 1.698* 0.071 1.598
US Investment 0.412 1.717*
Asia Investment 0.229 0.867
Fund of Funds Investment -0.073 -1.363 -0.173-
2.191**-0.229 -1.809* -0.102 -1.575 -0.157
-1.962**
-0.088 -1.631
International Financial Reporting Standards 0.033 0.504 0.014 0.201 0.021 0.294 0.048 0.688 0.018 0.247 0.113 1.915*
Rank of Attractiveness of Returns to Sustainable Investment
0.121 2.344** 0.027 0.648
Chief Investment Officer Responsibility 0.406 2.327** 0.4763.219**
*0.459
2.957***
0.400 2.252** 0.441 2.415** 0.047 0.233
Log (Assets) 0.071 1.740* 0.066 1.531 0.038 0.776 0.073 1.793* 0.077 1.707* 0.048 1.409
Pension Fund 0.227 1.481 0.269 1.631 0.210 1.195 0.233 1.516 0.203 1.143 0.189 1.313
Insurance Company 0.219 1.341 0.286 1.726* 0.257 1.555 0.220 1.353 0.262 1.480 0.275 1.566
Number of Observations 100 100 100 100 100 100
Number of Observations where Dependent Variable = 1
43 43 43 43 43 29
Pseudo R2 0.072 0.124 0.143 0.076 0.167 0.120 64
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Data
Empirics
Conclusions
Conclusions(Part III)
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© Cumming & Johan (2013) Fund Management
Conclusions
Data
Empirics
Conclusions
• SRI in VC/PE for institutional investors that have:
– International investment focus
– Adhere to the International Financial Reporting Standards (IFRS)
– Individuals that work for the institutional investor do not compete for returns (i.e., the decision to implement SRI is centralized)
– Direct investments (not fund-of-fund investments)
• Similar determinants of SRI for VC/PE as for other asset classes
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Data
Empirics
Conclusions
Chapter 4 Summary
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Summary of the 3 Big Picture Issues in Chapter 4
I. What do institutional investors care about when investing in VC/PE funds?
II. How does this affect VC/PE fundraising?
III. When/why are specialized VC/PE fund mandates of interest to institutional investors?
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