The 2016 Preqin Global Private Equity & Venture Capital Report

Persistence is Dead...Long Live Persistence

- Prof. Oliver Gottschalg, Head of Research, PERACS
Maybe one of the most fundamental
questions for investors is the degree
to which a certain asset class shows
performance
persistence,
or
put
differently, to what extent investment
opportunities that in the past have
generated outperformance are more
likely to also generate outperformance
in the future. Implicitly, any analyses
based on past performance assume
at least some degree of performance
persistence, or else the analysis of past
returns would be meaningless. There
is ample evidence that in most asset
classes, performance persistence is
merely an illusion1. However, in private
equity, academic studies provide
evidence that there is indeed some level
of performance persistence2.

Fig. 1: Kaplan and Schoars Historic Persistence Account

Using PME
Lower Tercile

Medium Tercile

Upper Tercile

Lower Tercile

44%

37%

19%

Medium Tercile

24%

34%

42%

Upper Tercile

11%

34%

55%

Lower Tercile

Medium Tercile

Upper Tercile

Lower Tercile

49%

31%

20%

Medium Tercile

30%

38%

32%

Upper Tercile

21%

31%

48%

Using IRR

Source: Kaplan and Schoar

Fig. 2: Improved Hit Rate Based on IRR for Pre-2002 Vintage Funds
The traditional method of assessing
private equity performance persistence
is based on the assessment of the
degree to which a fund (the successor
fund) managed by a GP, whose prior
fund (the predecessor fund) of the same
strategy and geography, was in a certain
performance category, is more likely
than random to be also in that same
performance category.

IRR Quartile

Subsequent
1st Quartile

Subsequent
2nd Quartile

Subsequent
3rd Quartile

Subsequent
4th Quartile

Improved Hit
Rate

Prior 1st Quartile

33%

20%

17%

30%

1.33

Prior 2nd Quartile

23%

14%

43%

20%

0.57

Prior 3rd Quartile

23%

28%

30%

20%

1.20

29%

15%

24%

32%

1.27

th

Prior 4 Quartile

1.18
Source: Preqin and PERACS

In an example provided by Kaplan and

Schoar (2005) (Fig. 1), a fund whose
predecessor was in the performance
category of the top tercile, i.e. the best
33% of funds compared to its vintage
year peers, in terms of IRR, has a 48%
probability of again producing top-tercile
returns for its successor funds. As the
random likelihood of a predecessor
fund ranking in any given tercile is
33.3%, this corresponds to an increased
likelihood that the new fund will again
be ranked in the same tercile by a factor
of 1.44x. Averaging this increased hit
rate across all performance categories
could be seen as an overall indicator
of persistence. This indicator would
be 1.35x3 in the Kaplan and Schoar
table, which considered pre-1996 fund
vintages.
Performance Persistence and
Subsequent Portfolio Returns
While the likelihood of hitting the same
tercile has intuitive appeal as a measure
of performance persistence, it may not
be conclusive as an indicator of whether,
and with what likelihood, investors are
indeed able to improve their portfolio
returns by systematically investing
with past winners. If we consider

Fig. 3: Improved Hit Rate Based on PERACS Alpha for Pre-2002 Vintage Funds
Alpha Quartile

Subsequent
1st Quartile

Subsequent
2nd Quartile

Subsequent
3rd Quartile

Subsequent
4th Quartile

Improved Hit
Rate

Prior 1st Quartile

32%

20%

27%

21%

1.29

Prior 2nd Quartile

25%

19%

33%

22%

0.78

Prior 3rd Quartile

7%

33%

37%

23%

1.49

Prior 4th Quartile

34%

12%

22%

32%

1.27
1.21

Source: Preqin and PERACS

Fig. 4: Improved Hit Rate Based on IRR for 2000-2004 Vintage Funds
IRR Quartile

Subsequent
1st Quartile

Subsequent
2nd Quartile

Subsequent
3rd Quartile

Subsequent
4th Quartile

Improved Hit
Rate

Prior 1st Quartile

28%

32%

24%

16%

1.12

Prior 2nd Quartile

29%

21%

33%

17%

0.83

Prior 3rd Quartile

19%

26%

30%

26%

1.19

14%

18%

32%

36%

1.45

th

Prior 4 Quartile

1.15
Source: Preqin and PERACS
1

See, for example, Carhart et al. (2002) or Bares, Gibson and Gyger (2002).
2
See Kaplan and Schoar (2005) or Phalippou and Gottschalg (2009).
3
((49/33)+(38/33)+(48/33))/3=(1.48+1.15+1.45)/3=1.35

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The 2016 Preqin Global Private Equity & Venture Capital Report

a case in which those 21% of funds

preceded by top tercile funds from the
Kaplan and Schoar analysis were, for
whatever reason, to be found at the very
bottom of the performance spectrum
of their respective vintage years, it
may theoretically be possible that the
aggregate performance of funds raised
by GPs that were past winners (that
is, a combination of an above-average
number of top tercile funds, an average
number of middle-tercile funds, and few,
but really poorly performing, bottomtercile funds) was no different from the
average performance of all funds taken
together.
Whether and in which circumstances
the backing of past winners leads to
a statistically significant increase in
portfolio returns is hence an empirical
question and can be statistically tested
using a sample mean comparison (t-test)
that compares the performance of the
sample of funds preceded by winners
with the performance of all other funds.
This test shows whether, and with what
statistical significance, outperformance
can be expected based on a persistencedriven investment approach.
We replicated Kaplan and Schoars
analysis using a larger and more recent
dataset from Preqin. Here, we analyzed
quartile-based performance persistence
across 175 pairs of pre-2002 vintage
buyout funds (Fig. 2). We observe an
improvement in the hit rate for topquartile funds of 1.33x, which is in line
with Kaplan and Schoars performance
terciles. We then dug deeper and
compared the performance of the
sample of funds preceded by winners
with the performance of the sample of
funds preceded by non-winners. The
assessment reveals, however, that
statistically speaking, the difference is
non-significant (that is, not different
from zero, considering the variance in
returns across the overall population of
funds).
This result is in line with the findings
from several recent academic papers,4
which suggest that for deals made since
the late 1990s, performance persistence
can no longer be found. In the Preqin
data, we also observe a decrease in
the hit rate improvement for top-quartile
funds with 2000-2004 vintages of 1.12x
compared to 1.33x for pre-2002 vintage
years (Fig. 2 and Fig. 4). There seems to
be strong evidence from different studies
using various data sources that since
the turn of the century investing in past
outperformers in terms of IRR no longer
leads to any substantial performance
improvements.
4

Fig. 5: Improved Hit Rate Based on PERACS Alpha for 2000-2004 Vintage Funds
Alpha Quartile

Subsequent
1st Quartile

Subsequent
2nd Quartile

Subsequent
3rd Quartile

Subsequent
4th Quartile

Improved Hit
Rate

Prior 1st Quartile

33.33%

26%

19%

22%

1.33

Prior 2nd Quartile

23%

18%

36%

23%

0.73

Prior 3rd Quartile

15%

31%

42%

12%

1.69

Prior 4th Quartile

26%

9%

26%

39%

1.57
1.33

Source: Preqin and PERACS

IRR Issues in Measuring Performance

Persistence
The overall concept of measuring
performance persistence can be applied
to different performance measures.
Existing studies assessed persistence
mostly based on IRR-type approaches.
Given the important methodological
shortcomings of the IRR measure, and
the fact that it looks at absolute and
not relative performance and is hence
heavily influenced by macroeconomic
factors, it is interesting to explore to
what extent the absence of IRR-based
performance persistence for the more
recent vintage years may be due to
these IRR shortcomings alone. It may
well be possible, for example, that the
IRR bias pushes a GPs fund without any
superior value generation capability into
the IRR top quartile due to a coincidental
successful early exit, while the next fund
falls into the lower quartile that is more
appropriate for this GP. Similarly, GP
funds may have been pushed into the
IRR top quartile due to an exceptionally
positive market environment during their
respective investment periods, while
their next funds did not benefit from
any such uplift. The extreme shifts in
market conditions we have seen since
the beginning of the century made such
scenarios plausible.
One possible way to gain deeper insight
into the degree to which diminishing
persistence can be attributed to the
methodological issues of IRR (and
its variants) alone, is to replicate the
aforementioned analyses using the
PERACS alpha, which corrects for the
methodological IRR bias and expresses
performance net of public market
returns. Indeed, the results confirm our
hypothesis, as we observe a meaningful
level of persistence (based on improved
top-quartile hit rates) not only for the
pre-2002 funds (1.29) but also for 20002004 vintage funds (1.33). Importantly,
we further observe a reasonably strong
(0.26 coefficient) and highly significant
(0.99 level) correlation between the
predecessor fund PERACS alpha and
successor fund PERACS alpha.

Finally, this PERACS Alpha persistence

translates into an important improvement
in overall portfolio returns, as an investor
backing past winners in terms of the
PERACS alpha would have historically
enjoyed a statistically significant (t-test
of 1.74) improvement in portfolio returns,
namely an increase in PERACS alpha
of 3.8% per year over the returns of a
randomly chosen portfolio. This finding
has important implications for investors
as performance in the private equity
asset class seems to still be driven by
persistence. However, there is a caveat
to identify funds which will more likely
lead to outperformance, one will have
to look beyond the IRR performance
measure.
This is an extract from Private Equity
Mathematics by Prof. Oliver Gottschalg.
PERACS
PERACS is a leading provider
of independent track record
performance certification services
for the private equity industry,
offering exceptionally powerful
statistical methods for identifying
key
attributes
of
a
funds
performance, its risk profile, and
its strategic differentiators. This
comprehensive set of standardized,
quantitative metrics is generated at
the deal, fund and portfolio level,
cumulatively and continuously, for
periodic reporting. General partners
use PERACS to demonstrate
competitive positioning, not only
for internal use but to enhance
fundraising
effectiveness
and
efficiency and for ongoing investor
communication. Limited partners
use PERACS to provide unique
perspective into portfolio risk and
return profile with application
in portfolio design, investment
decision support and optimizing
performance.
www.peracs.com

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2314400 and http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2304808

For more information about the report, please visit: www.preqin.com/gper

alternative assets. intelligent data.