PitchBook News - Predicting performance

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August 26, 2023
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Predicting performance: How persistent are private fund returns?
"Past performance is not a guarantee of future results."

All investment professionals are familiar with the phrase, which is more than just legal fine print to cover any liability when discussing financial returns. The words are a simple warning stemming from lived experience; relying on a manager's or an asset’s track record to drive investment decision-making has led many capital allocators astray.

And yet, the temptation to chase returns is a recurring theme that takes shape in various formats across asset classes. In private markets specifically, the belief in "top quartile" managers is pervasive, resulting from past research that suggests the top-performing general partners tend to keep outperforming.

Further, the empirical data on performance dispersion between top and bottom quartiles (up to 20%+ deltas in IRR depending on the vintage and strategy) signals that GP selection is incredibly important. Plus, a commitment can be locked up for 10 or more years, which means getting the selection wrong offers a painful lesson in opportunity costs.

Enter the theory of performance persistency.

Its underpinnings seem valid enough. The opportunity set for private markets is vast, and a GP's access to deals is not uniform like it is, say, in US public equities, where investors have the same list of a few thousand stocks to choose from. Add the fact that private market GPs offer operational expertise and hands-on support, and it's easy to imagine that a GP's alpha can be persistent.

Our latest research puts that theory to the test. We look to the returns generated across closed-end funds in GPs' fund families (a sequence of funds in a similar strategy), leveraging components of our newly released Performance Score framework. Our results for PE, VC, real estate, and funds of funds suggest that performance persistency does in fact exist in private markets, but

…the practical implications for capital allocators are limited.

Overall, we found that strong performance in a family's prior funds was correlated with strong performance in successor funds to some degree, but that's when looking at the most recent available returns data. To be useful for the allocator's decision to invest, persistency must be predictive at the time a new commitment can be made.

The issue―which we and others have found―is that early IRRs are notoriously unreliable indicators of where a fund's performance eventually ends up. At the time the next sequence in the family is fundraising, the predecessor fund is on average only 3.5 years old, leading to a high degree of drift from that time to its final IRR. The vertical distance between each dot and the 45-degree line in the scatter plot below corresponds to the amount of drift each fund has experienced.

Relationship between IRR at time of successor's fundraise and latest available IRR
 


We find that, after controlling for information on prior fund family returns that was available at the time a successor was fundraising, the predictive power of a GP's track record is near zero.

In our latest Allocator Solutions report, we explore this data and more. While we don't recommend using past performance to predict future results, there are other practical takeaways for allocators gauging a manager's track record.

To read more, download our research: Evaluating Persistence in Fund Performance.

Also, check out our webinar from this week, where we dive into this analysis and our broader Manager Performance Scoring framework.

As always, we appreciate any questions and feedback.
 
Best regards,

Zane Carmean, CFA, CAIA, Lead Analyst, Quantitative and Funds Research

Andrew Akers, CFA, Senior Quantitative Research Analyst
 
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Market Updates  
 
Private capital fundraising has been declining since Q4 2021, a trend that started at the end of last year.

Nevertheless, allocators continue to make commitments because a down market has historically resulted in the best-performing funds, according to our new Global Private Market Fundraising Report.

This year, private debt funds have made gains relative to other strategies, while VC and real assets have fallen:
read the free report
 
 
Industry & Tech Research  
 
The retail fintech slowdown has continued.

VCs invested $1.9 billion across 188 deals in Q2, declines of 33.4% and 0.5%, respectively, from the previous quarter.

Still, investors are eyeing emerging opportunities in the startups leveraging generative AI and others offering "save now, buy later" options for consumers, according to our new Retail Fintech Report:
read a free preview
 
 
There are signs that dealmaking in the logistics industry is stabilizing—notably, an uptick in VC deal value in Q2.

The five largest supply chain tech deals of last quarter, including Getir's massive down round, brought in half of the $3 billion in VC deal value accrued across 190 deals.

Warehouse automation and drone delivery are segments making remarkable headway, according to our new Supply Chain Tech Report, with companies such as Locus Robotics and Covariant staying especially competitive:
read a free preview
 
 
Crypto deal value and count fell for the fifth consecutive quarter—and to their lowest points since Q4 2020.

But there are still opportunities for investors, such as stablecoins, according to our new Crypto Report.

Startups are also working to create fairer markets by mitigating the effects of transaction manipulation:
read a free preview
 
 
In the News  
 
Lead analyst Kyle Stanford talks VC with Yahoo Finance.

Our insights and data featured in the press:
  • Discussing how startups are navigating a challenging market environment. [Yahoo Finance]

  • Senior tech analyst Robert Le joins CNBC's Crypto World to dive into key takeaways from our latest crypto research. [CNBC]

  • Private debt has stood out among other private capital strategies when it comes to fundraising. [Institutional Investor]

  • "Over the last two years we've seen a notable shift in both funding and the structure of the on-demand delivery market." [The Guardian]

  • Pharmaceutical companies distributing essential drugs is "certainly a viable path to commercial success" if the company is capable of mass distribution. [Forbes]
If you're a journalist interested in interviewing our analysts or requesting data, contact our PR team.
 
Webinars & Events  

Insights into investment firm compensation

We're teaming up with J. Thelander Consulting to discuss how compensation trends at VC and PE firms have changed in recent years, and what to expect going forward.

Join us on Sept. 13 to see data on base salaries, bonuses, carried interest, and more across a range of positions from managing general partners to entry-level analysts.

The event is free to attend: register here
 
ICYMI  

Highlights from our other recent research:

Market updates
Thematic research
Industry & tech research
Coming next week (subject to change)
  • Public PE Roundup
  • Vertical Snapshot: Space Tech
  • Clean Energy Tech Report
  • Emerging Space Brief: Neurotechnology
 

Thanks for reading! Feel free to email us any time with feedback, questions, or tips!

Learn more about the PitchBook Institutional Research Group, meet our analysts, or access our research libraries for clients and non-clients.

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