That past performance is not an indicator of future returns is a disclaimer we’ve all heard many times. But for private equity LPs, who have remained loyal to their favorite GPs fund after fund, this may ring counterintuitive. Fund loyalty notwithstanding, recent studies have shown that performance persistence, specifically in private equity funds since 2002, can no longer be found. So, how are LPs supposed to make investment decisions?
Recently, PERACS conducted its own research into the persistence of PE returns using Preqin data, IRR and its own proprietary performance benchmark, PERACS Alpha. When using IRR, PERACS recreated the findings of earlier studies, namely that performance persistence has disappeared from private equity. But has the industry fundamentally changed or is something else going on?
By replicating the aforementioned return persistence analysis using its own benchmark PERACS Alpha, which corrects for methodological IRR bias and expresses performance net of public market returns, PERACS arrived at much different overall results. The analysis observed a meaningful level of persistence in top-quartile PE funds across all vintage years. In other words, strong PERACS Alpha performers in previous funds were likely to be strong PERACS Alpha performers in subsequent funds.
PERACS has long recognized IRR’s shortcomings as a performance measure. IRR tends to disproportionately value a fund cycle’s early wins and disregards public market performance, both in terms of opportunity cost and post-distribution returns. It would appear that the apparent lack of return persistence in private equity may be due to studies’ overreliance on this faulty measure, rather than any true underlying lack of PE performance persistence.
Overall, the findings were clear. PERACS Alpha was a more accurate indicator of performance and performance persistence over time, regardless of vintage year.