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Private Equity cash flows and performance patterns

Author: Nik Morandi and Andrea Carnelli
Date: September 2014

In selecting a general partner’s (“GP”) latest fund and assessing whether the fund has the potential to be a top quartile performer, investors typically assess track record alongside more subjective elements, such as the purported strengths and experience of investment team members.

Pantheon has conducted a quantitative study to review whether there are characteristics of private equity funds, most of them cash flow-based, that certain quartile performers share in common. In particular, the study compared the patterns of cumulative calls, distributions, NAV uplifts and the J-curve in the first five years of a buyout fund’s life, and found that some of these signals were commonly shared by funds with top quartile performance versus bottom quartile performance. Whilst it is not possible to predict future performance outcomes, our research has identified some statistically relevant factors that, although not deterministic, were associated with final fund quartile rankings.

The study highlights that funds that distributed or wrote-up portfolio company valuations more than their peers within the first few years from inception generally featured a substantially higher probability of ranking top quartile than bottom quartile. Conversely, a variable pace of capital deployment during the early years of a fund’s commitment period appears to carry no relevant or statistically significant information about future  performance. Monitoring certain data of private equity funds, including the pattern of cumulative calls, the amount of distributions, NAV uplifts and the depth of the J-curve, in the first few years of their investment cycles can help investors to actively manage portfolios, for example by retaining or increasing allocations to what the investors believe could be funds with the potential to perform well at the expense of positions indicating
a higher probability of lower performance. In addition, judging that a general partner’s current fund is on track to be a top quartile performer, even when companies are immature and all capital is yet to be invested, may improve decision-making in secondary purchases of less mature portfolios. Finally, these datapoints can influence the due diligence process during subsequent fundraisings by the same GP.

Geography: North America

Type of study: Consulting research

Relevant for: LP, GP All, Fund of Fund, Associate

Source: Pantheon, in>focus