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Do Loss Rates Indicate Risk in Private Equity?

Author: Chris Ragazzo
Date: February 2015

In contrast to the public markets, assessing risk and return characteristics in the private equity asset class requires more than simple quantitative analysis. Given the illiquid nature of the assets, which are typically priced quarterly rather than daily, and private equity’s subjective valuation methods, measuring risk has proven to be an especially challenging problem. Various academic efforts to quantify the volatility of private equity portfolios and related risk have met with limited success. This has left practitioners with few tools available to easily measure the risk associated with a private equity portfolio. Investors have used a variety of metrics in an attempt to assess volatility and risk in private equity, including tracking error of the annualized IRR versus the selected public markets benchmarks, and change in portfolio valuations from one time period to the next. Both of these measures focus on short‐term movements in valuations, and do not take into account the long‐term nature of private equity. In this brief paper, we consider the advantages and disadvantages of loss rates as a measure of risk.

Geography: US

Type of study: Consulting research

Relevant for: All

Source: Abbott Capital