in focus

Private Equity Cash Flows and

Performance Patterns
By Nik Morandi, Partner and Andrea Carnelli, Vice President
September 2014

Private Equity Cash Flows and Performance Patterns

SUMMARY
In selecting a general partners (GP) latest fund and assessing whether the fund has the potential to be a
top quartile performer, investors typically assess track record alongside more subjective elements, such as the
purported strengths and experience of investment team members.
Pantheon has conducted a quantitative study to review whether there are characteristics of private equity funds,
most of them cash flow-based, that certain quartile performers share in common. In particular, the study compared
the patterns of cumulative calls, distributions, NAV uplifts and the J-curve in the first five years of a buyout funds
life, and found that some of these signals were commonly shared by funds with top quartile performance versus
bottom quartile performance1. Whilst it is not possible to predict future performance outcomes, our research
has identified some statistically relevant factors that, although not deterministic, were associated with final fund
quartile rankings.
The study highlights that funds that distributed or wrote-up portfolio company valuations more than their peers
within the first few years from inception generally featured a substantially higher probability of ranking top
quartile than bottom quartile. Conversely, a variable pace of capital deployment during the early years of a funds
commitment period appears to carry no relevant or statistically significant information about future performance.
Monitoring certain data of private equity funds,
including the pattern of cumulative calls, the amount
of distributions, NAV uplifts and the depth of the
J-curve, in the first few years of their investment cycles
can help investors to actively manage portfolios, for
example by retaining or increasing allocations to what
the investors believe could be funds with the potential
to perform well at the expense of positions indicating
a higher probability of lower performance. In addition,
judging that a general partners current fund is on track
to be a top quartile performer, even when companies
are immature and all capital is yet to be invested, may
improve decision-making in secondary purchases of
less mature portfolios. Finally, these datapoints can
influence the due diligence process during subsequent
fundraisings by the same GP2.

KEY OBSERVATIONS

This study has found that funds that distributed

more than their vintage peers during the first few
years of their commitment period were more likely
to be top quartile performers over the long term
High NAV uplifts relative to the vintage cohort
also indicated a higher probability of future
outperformance in the dataset
A deep J-curve, relative to vintage peers, signalled
a significantly higher probability that a fund would
end up bottom rather than top quartile
The level of cumulative calls appeared to carry no
relevant information about future performance
outcomes

The methodology of the quantitative study is described in detail on page 6.

Past performance is not indicative of future results. This material is not intended to be, and should not be perceived as, a belief that Pantheon can project or predict potential fund or manager performance or potentially forecast investment results. This material is a quantitative study utilizing
proprietary research into potential performance indicators that may further educate known, sophisticated private equity investors regarding active portfolio
management.
1
2

SEPTEMBER 2014

INTRODUCTION TO THE STUDY

This paper asks whether there are common characteristics among funds that have outperformed based on the
analysis of cash flow patterns and other performance characteristics in the early stages of a funds life. This question
finds no answer in academic literature3, which has mainly focused on the issue of performance persistence across
funds managed by the same GP. There is clearly much to be gained from selecting top quartile funds, not least given
the spread between top and bottom quartile performance (otherwise known as the inter-quartile range) in private
equity: when looking at all private equity funds from 1979, the average IRR is 13.6% for upper quartile funds, but
only -1.6% for lower quartile funds4.
In this study, Pantheon analyses cash flow and performance data from Preqin for vintages between 1992 and 20075.
Performance is defined in terms of the common Total Value to Paid In (TVPI) return metric, but the results were also
robust when using IRRs. (Please see the below section entitled Methodology for further details on the methodology
and approach taken).

HIGH CALL RATE DID NOT SIGNAL OUTPERFORMANCE

Many investors take a higher-than-average rate of capital calls to be a hallmark of a confident general partner that
is deploying capital from a new fund quickly and consistently because its investment team is finding a stream of
attractive investments.
The findings do not support that hypothesis (see Figure 1 overleaf6). Our results showed that funds that called more
than their peers (as a proportion of total fund size or aggregate commitments) in any given vintage did not have
a higher probability of ranking top quartile. Indeed, funds that drew down a higher proportion of investor capital
compared to vintage peers appeared more likely to end up in the bottom quartile. One explanation for any potential
underperformance stemming from a high call rate is that GPs could tendentially increase the pace of investment when
overall market conditions are more stable, when credit markets are at their most liquid and when confidence levels
are rising exactly the sort of conditions often associated with a more expensive valuation environment. It is an area
that merits further investigation, and Pantheon will be considering it in a coming study that looks at whether or not
GPs investment and divestment patterns are generally pro-cyclical or anti-cyclical, and whether certain behavioural
patterns can be identified.
With respect to the performance-related aspect of a GPs call rate, however, we were able to conclude that the call
rate was not a reliable or meaningful indicator. The apparently higher probability of a high call rate fund ending up
bottom rather than top quartile was not a statistically significant outcome.

See for instance: Harris, R.S., T. Jenkinson, S. N. Kaplan, and R. Stuecke. 2013. Has Persistence Persisted in Private Equity? Evidence from Buyout and Venture Capital Funds. Darden Business School Working Paper No. 2304808.
4
Source: Thomson One and Bloomberg. All data to 30 September, 2013. Thomson Quartile data relates to all Private Equity across all regions from the Thomson One database.
5
Earlier vintages were excluded due to an insufficient number of available funds, while later vintages were excluded in order to ensure a sufficiently mature
set of investments. Please see Methodology on page 6 for further information.
6
Please see Methodology for an additional explanation on Figures 1 4.
3

Private Equity Cash Flows and Performance Patterns

Figure 1: Cumulative Calls

Top quartile

35%

Bottom quartile

30%
25%
20%
15%
10%
5%
0%
1y

2y

3y

4y

5y

Please see "Methodology" for an explanation of Figure 1.

HIGHER DISTRIBUTIONS AND NAV UPLIFTS SIGNALED OUTPERFORMANCE

Whilst the level of calls did not seem correlated to performance, the study indicates that distributions and uplift
movements yielded more conclusive results. The study found that funds that distributed more than their vintage peers
during a typical five-year commitment period were more likely to rank as top quartile in later years (see Figure 2). This
effect is noticeable from the second year of a funds life, and is substantial and highly statistically significant by year
five: funds that distributed more than their vintage peers (i.e. those that fall within the top 25% of their vintage cohort
in terms of the level of distributions relative to total fund size), featured more than a 40% probability of eventually
ranking top quartile.
Early distributions did not necessarily result from portfolio company exits during the early stages of a funds commitment
period. These can also be generated through asset disposals of non-core operations, or refinancings where the GP
increases the debt load on a particular asset in return for an equity distribution back to limited partners (commonly
referred to as dividend recapitalizations). Taken together, these activities can be a reflection of a nimble GP, attuned
to exit and credit market conditions, capable of taking advantage of attractive liquidity environments even in the
very early stages of a fund. Irrespective of whether some of these distributions may be recallable by the GP for
re-deployment into future investments, it could be argued that the link between GPs capable of acting in this manner
and future fund outperformance seems intuitive.
Nevertheless, the results of our study did not simply corroborate what one might view as self-evident or tautological for
three reasons, each suggesting that the relationship between high distributions and performance is mechanically not
related. First, the analysis related final fund performance to early distributions: a fund that produced large distributions
in the early stages did not necessarily keep up the pace as it matured. Second, the analysis employed TVPI as a
performance metric, which did not overweight early distributions. Finally, this study concluded that funds that were top
performers distributed the large part of their total distributions after the period that the relevant time frame measured.
Figure 2: Cumulative Distributions
Top quartile

50%

Bottom quartile

40%
30%
20%
10%
0%
1y

2y

3y

Please see "Methodology" for an explanation of Figure 2.

4y

5y

SEPTEMBER 2014

In a similar vein, funds that wrote-up their assets more than their vintage peer group in their early years were more
likely to go on to outperform. The results were apparent even earlier in the fund life than is the case for distributions.
A fund that reported a high pace of valuation write-ups (in relative terms) in its first year was more likely to end up in
the top quartile; by the second year, the relationship between the rate of NAV uplifts and final quartile ranking was
very strong and highly statistically significant (see Figure 3).
It is worth noting that the study is based on fund vintages up until 2007, after which point the industry widely
adopted FAS 157 fair valuation reporting. While it is impossible to say if different reporting standards would have
influenced the findings of the study7 (this will become more apparent in the years to come), the shift did place an
onus on GPs to record increased valuations more accurately and in a more timely fashion, thus improving overall
clarity around company values.
Figure 3: NAV Uplift Rate
Top quartile

Bottom quartile

60%
50%
40%
30%
20%
10%
0%
1y

2y

3y

4y

5y

Please see "Methodology" for an explanation of Figure 3.

Taken together, our research showed that a high rate of distributions and portfolio uplift can be signals of positive
early momentum in funds. One view is that they can also be signs, or perhaps causes, of a positive mindset that can
often be observed among certain GPs. In particular, one could suggest that early success and delivering capital back
to investors can foster the confidence to take tougher decisions in later years, or assume more risk elsewhere in the
portfolio with the objective of driving fund performance over the longer term.
In contrast, one can speculate that GPs that take early knocks to their portfolios or witness little early success may be
inclined to hunker-down, and can lack the incentive or the confidence to make decisions and investments that could
potentially lead to stronger performance in the long-run.
J-CURVE DEPTH AS A SIGNAL OF UNDERPERFORMANCE
Our study has so far demonstrated that the patterns of calls from the funds in the data set were not statistically
significant to the future performance of a fund, but distributions (and the rate of valuation increases) could be. It is
natural to ask whether a joint analysis of the combined impact of calls and distributions can provide some insight.
The relationship between calls and distributions is reflected in the private equity J-curve the difference between
the level of cumulative distributions and calls and how this relationship varies over time8. The study suggests that
the deeper a funds J-curve (i.e. the more negative or less positive the net cash position of a fund at any given
point in time), the lower the probability that the general partner was able to recover from this profile and generate

Our study included fund vintages between 1992 and 2007 but examined fund performance data up until 2013; as a result, the study included NAV information both pre and post the implementation of FAS 157.
8
Note that for the purposes of our study, our definition of the J-curve only takes into account calls and distributions since we are seeking to isolate the net cash
flow profile of a fund; we have therefore not included NAV in our J-curve definition.
7

Private Equity Cash Flows and Performance Patterns

eventual top quartile performance (see Figure 4 below). While the results were noticeable from year two of a funds
life, by year three the effect on performance was marked and statistically significant. If an investors portfolio was
still deep in J-curve territory by year five relative to vintage peers, this persistency was a very clear signal of potential
underperformance in later years.
Figure 4: J-Curve Depth
Top quartile

40%

Bottom quartile

30%
20%
10%
0%
1y

2y

3y

4y

5y

Please see "Methodology" for an explanation of Figure 4.

CONCLUSIONS
We believe the findings of the study have applications that can help investors both manage their primary portfolios
and can help in the diligence of secondary investment opportunities.
The ability to analyze early cash flow and NAV uplift data can provide additional supporting information for an
investor looking to manage out underperforming components of a private equity portfolio, and consider doing so at
an earlier stage, before that underperformance is fully crystallized or becomes evident. Capital freed up in this way
can then potentially be redeployed into other funds.
Analysis of current immature funds can also be invaluable when assessing new primary investments. The ability to
evaluate patterns of calls, distributions and NAV uplifts of a GPs current fund can inform a decision when considering
an investment in a subsequent fundraising.
The analysis of factors like calls, distributions, NAV uplifts and the depth of the J-curve during the early years of
a funds term will not replace analysis of a GPs past performance, or assessments of the skills and stability of an
investment team. But the results corroborate that they merit being considered by sophisticated private equity investors
that want to improve fund and manager selection, and manage their portfolios more actively.

SEPTEMBER 2014

METHODOLOGY
The data consisted of calls, distributions and interim valuations (NAV) for 322 US buyout funds (vintages: 1992-2007)
based on fund performance data up to and including Q2 2013 as reported by Preqin. All data was standardized
by fund size. We considered four types of performance metrics (described herein as cash flow or performance
signals) at each fund age (years 1 to 5): level of cumulative calls, level of distributions, NAV uplift rate (average of
value changes adjusted by lagged NAV), and depth of J-curve (total net cash flows, which is equal to cumulative
distributions less cumulative calls). The relationship between cash flow patterns and final fund performance (TVPI)
was investigated non-parametrically: we grouped funds based on their performance characteristics at a specific
fund age, and then asked whether any group included a large number of top performing funds (based on TVPI).
In order to ensure that results were comparable across vintages, we assigned fund quartiles for each performance
metric. For each performance metric at each fund age (years 1 to 5), we calculated the distribution of performance
across quartiles. In order to determine which performance metrics were statistically significant in our results, we
tested the null hypothesis that performance is evenly distributed across quartiles via a Chi-squared test.
Figures 1 - 4 illustrate how the pattern of cash flows (and NAV) was tied to final fund performance at different
stages of fund life (from year 1 to year 5). Blue and orange bars represent the probability that a fund ranked, by
the end of its life or latest available data at Q2 2013, as top or bottom quartile, respectively. The performance
metrics consist of top quartile cumulative calls (Figure 1), top quartile distributions (Figure 2), top quartile NAV
uplift rate (Figure 3), and bottom quartile J-curve (Figure 4). Quartile classifications of cash flow and NAV signals
are vintage-specific.

Private Equity Cash Flows and Performance Patterns

IMPORTANT DISCLOSURE
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