PitchBook News - Taking the private out of PE

PE buyout strategies—and private markets, more generally—are often touted as "alternative" investments.

The word "alternative" in this context has mainly become a catch-all for anything that is different than a narrow set of traditional long-only asset classes, including publicly traded equities, rated credit, Treasury bonds, and cash.

Many investors extend this definition of alternative investments to include a perceived diversification benefit to traditional portfolios.

Despite its label as an alternative, PE buyout shares many of the fundamental investment characteristics with those of traditional public equities strategies. At their core, both private and public equity investing involve the ownership of current and future earnings of corporate businesses.

By extension, managing a portfolio of private companies has key similarities with managing a benchmark-agnostic equity portfolio of public companies in terms of generating alpha. The two main alpha drivers, sector and security selection, apply to both private and public equities.

How different then is PE buyout as an asset class?

One way to approach this question is to determine how much of the buyout model—investing in relatively small, underperforming companies that still generate enough free cash flow to service an increased debt burden—can be systematically replicated in the public markets.

To do so, we created a neural network that systematically captures the fundamental characteristics of buyout investing in a sample of public equities using take-private transaction data, quarterly financial statements, and stock price data. We then adjusted this model-based portfolio for leverage and sector exposures to construct a buyout replication portfolio: the PitchBook BRP.

 

Click to read more on our buyout replication portfolio.