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Private equity funds report quarterly net asset values to their investors, based on an appraisal of the value of companies in their portfolio. These valuations are used by investors to calculate the performance of their alternative asset portfolios and overall pension plan performance. We investigate the time-series features of reported private equity returns. Specifically, we identify the betas and alpha contained in the average returns on U.S. private equity funds by benchmarking against passive exposures from public equity markets. We also gauge the consistency of our estimates over time and discuss their reliability.
Estimates from the full period of available data reveal that U.S. Buyout funds (Buyout) have an equity market beta of around 0.85-0.90, are negatively exposed to size and value, and lag public markets by up to four quarters. That is, investing in Buyout funds is similar to investing in small-cap equity with growth attributes, but with returns distributed over time. Further, we estimate that Buyout generated significantly positive alpha of about 5.6% per annum, relative to passive investments. Venture capital (VC) funds demonstrate similar tendencies, although the estimates differ. The equity market beta for VC is around 0.75, while exposure to size and growth is insignificant. In contrast to Buyout, VC funds delivered negative alpha, although this was insignificant and the exact magnitude depends on the benchmark used.
However, analysis of 10-year rolling data reveals that estimates of alpha and beta are inconsistent through time. For both Buyout and VC, 10-year market betas well exceeded 1 during most of the 2000s, but are noticeably lower prior to 2000 and after 2008. The positive Buyout alpha estimated over the full period was sourced primarily prior to the mid-2000s, with alpha fading notably in the latter part of the period. Meanwhile, VC alpha appears to be cyclical. We propose that shifts in valuation practices and funds invested are partly responsible for the variation.
Our work has implications for both performance evaluation and investment. We confirm the need to account for size and value exposures when evaluating performance, most notably for Buyout funds, as well as incorporating lagged terms when using return data to either analyze performance or estimate betas. Further, we highlight the need to allow for time-varying beta exposures.
While we find...