Pursuing Persistence in the Private Markets
The debate around persistence of returns in private markets has persisted longer than returns themselves depending on which side you believe. One oversight of this debate, however, is that nearly all the research has been focused on the firm–level. The question of persistence has become, “Do top quartile funds’ successors also go on to be top quartile?”
McKinsey carried out research on this topic in 2017, based on vintages from 1995 through 2013. The research found just 12% of buyout funds repeat top quartile performance, the result of a steady decline since 1995. The research also finds manager’s persistency of performance in general to be low (figure 1).
One notable exception to this type of firm-level research was a study by Ewens and Rhodes-Kropf (2015) who demonstrated that individual partners at venture capital firms show greater persistence of returns than the firms themselves.
At eVestment Private Markets, our belief is that good due diligence is about looking past the headline performance numbers and understanding the actual drivers of performance. Ewens and Rhodes-Kropf’s research highlight the importance of applying a more rigorous approach to analysis of a team as one of the key elements of an LP’s due diligence process.
From belief to execution
The starting point for such analysis is partner attribution or deal lead attribution. Some groups are very direct when it comes to deal ownership and it is very clear who is responsible for sourcing each deal.
Other groups take a more collegial approach where decisions are made by the investment committee and the “team owns the deal.” In this situation the fund manager may not provide deal attribution and investors will often reverse engineer the individual deal leads from the other due diligence materials or through research at the portfolio company-level.
eVestment TopQ+ tackles deal attribution in several ways. Users can use the People Widget to identify the individual track record of each deal lead, which, in expanded view, will also split out their performance as a lead versus other deal team members.
It is also possible to filter on Deal and Person to see the impact on any of the 26 widgets, or group by Deal and Person in the Matrix. Using this functionality, it is possible to dig into a particular partner’s individual track record, to see how their deals have performed over time and how persistent their returns have been.
Filling in the blanks
The scenarios outlined above depend on having complete and reliable data, which is not always the case. How does one handle the issue of deal team turnover? How a fund manager chooses to divulge such changes in their track record can vary considerably. At the extreme end, there can be a “re-writing of history,” whereby the departed deal lead’s deals are re-attributed to remaining deal team members. They will likely have been involved in those deals, but perhaps in a more junior role, or they may be responsible for monitoring the investment now, but not originally. If Ewens and Rhodes-Kropf are correct in their thesis on persistence, the true picture of who was leading successful deals is critically important to assessing the likelihood of success with a new fund.
eVestment TopQ+ can help with this as well with new MPA functionality that allows users to compare the track record supplied for the current fundraise with the one supplied during the last fund raise. This helps investors quickly see the key movements and changes during the intervening years. It helps answer questions like:
- Did their best unrealized deals turn out to be their best deals?
- Have they shifted focus either by sector, geography or deal size?
- Have they re-assigned lead partner responsibility for specific deals?
These concepts can be summarized neatly with an old industry mantra, “The secret to good private market investing is the three P’s, people, people, people.” And while the importance of people in private equity has not changed, the way we assess them has. The quantitative analysis of people’s track records and persistence available in TopQ+ can be just as important to the due diligence process as meeting the individuals in person.
Click the link below to learn more about the role TopQ+ can play in enhancing your analysis capabilities during the due diligence and manager selection process.