The Cream Stays at the Top – Persistence of Private Equity Manager Performance

by Truffle Team

Persistence of performance of Private Equity fund managers has been a topic of much industry and academic research. Whilst past performance is not indicative of future returns, there are some significant trends that investors should be aware of when selecting Private Equity fund managers.

Quartiles Explained: The analysis shown here is based on quartile performance, a standard approach for measuring the performance of a Private Equity fund relative to its peers. This involves ranking all funds in the data set from top performers through to the lowest performers, and grouping them into “quartiles”. Top quartile funds are therefore the top performing 25%, whereas 4th quartile funds are the lowest performing 25%.

1. Outperformance Persists

Top performing funds tend, more often than not, to be followed by a fund that also outperforms. For example, 74% of top quartile funds are followed by a fund that has outperformed (i.e. in the top two quartiles). Less than 10% of funds following a top quartile fund are in the bottom quartile.

Source: The Journal of Performance Measurement, Fall 2017. Notes: Percentage of large buyout funds that transition from a previous performance quartile to each current fund quartile. Results are for funds with vintage years from 1979-2010.

2. Underperformance Persists

The lowest performing funds, the 4th quartile, are often followed by a fund that also underperforms. 55% of 4th quartile funds are followed by a fund that has also underperformed (i.e. in the bottom two quartiles). This trend is weaker than the persistence of outperforming fund managers, though identifying the 45% of 4th quartile funds that will be succeeded by an outperforming fund is a difficult challenge.

Source: The Journal of Performance Measurement, Fall 2017. Notes: Percentage of large buyout funds that transition from a previous performance quartile to each current fund quartile. Results are for funds with vintage years from 1979-2010.

Conclusion

The data would suggest the investors would have experienced better returns by investing the in the follow-on funds of managers which have historically outperformed, and avoiding managers which have underperformed in the past. Consequently, identifying and gaining access to top performing fund managers is important.

It should be noted though that past performance is not indicative of future returns. As the data shows, there are numerous instances of top performing funds being followed by underperforming managers, and underperforming managers subsequently outperforming.

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