Do Diversified Private Equity Funds Mean Lower Returns?

Screen Shot 2014-12-04 at 10.10.43 PMWhile pension funds remain a major investor in private equity, a landmark study from the London Business School’s Collier Institute of Private Equity shows that they might not be investing in ways that drive highest returns.

The report, which explores SEC filings of 3,847 US- based private equity advisors, “is the first to provide a comprehensive analysis of the universe of private equity advisors that have recently started to register with the SEC.” It offers two fascinating sets of findings:

The first covers “commitments by pension funds and non-US investors.”

  • “Pension funds that invest with larger advisors, for which private equity represents a smaller proportion of their overall assets under management, potentially achieve lower returns.”
  • “Pension funds that invest with advisors whose executives have weaker incentives or who have a lower proportion of investment professionals relative to AUM potentially achieve lower returns.”
  • “Non-US investors are now an important source of funding for US-based private equity firms and are sophisticated.”

The second finding offers new evidence on how private equity advisors perform:

  • “A higher capital commitment by advisors to the private equity funds they manage correlates with better performance “
  • “Specialization in private equity is associated with higher return performance.”
  • “Smaller private equity firms have better incentive alignment.”
  • “Lack of compliance hurts performance.”

The Financial Times reports that the result is clear: “The more private equity groups branch out, the lower their returns tend to be.” The piece continues: “The findings cast a cloud on a recent trend of investors including pension plans and sovereign wealth funds concentrating their bets on the larger, more diversified managers.”

The London School of Business’ study offers a new view that could be useful to a range of audiences. As the Collier report concludes: “Our evidence is likely to inform both investors seeking to better understand the drivers of private equity returns and regulators, who are considering the potential implications of their regulatory activities.”