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Local Overweighting and Underperformance: Evidence from Limited Partner Private Equity Investments

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  • Yael V. Hochberg
  • Joshua D. Rauh
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    Abstract

    Institutional investors of all types exhibit substantial home-state bias when investing in private equity (PE) funds. This effect is particularly pronounced for public pension funds, where the local overweighting amounts to 9.7% of the private equity portfolio on average, based on 5-year rolling average benchmarks. Public pension funds’ own-state investments perform significantly worse than their out-of-state investments, an average of 3-4 percentage points of net IRR per year, and those that that overweight their portfolios towards home-state investments also perform worse overall. These underperformance patterns are not evident for other types of institutional investors, such as endowments, foundations and corporate pension funds, and we do not observe similar overweighting or underperformance of investments in neighboring states. Overweighting in home state investments by public pension funds is greater in states with higher levels of corruption, although there is no positive correlation of underperformance with corruption for these investors. The overweighting and underperformance of local investments cost public pension funds between $0.9 and $1.2 billion per year, depending on the benchmark.

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    File URL: http://www.nber.org/papers/w17122.pdf
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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17122.

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    Date of creation: Jun 2011
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    Publication status: published as Local Overweighting and Underperformance: Evidence from Limited Partner Private Equity Investments, 2013 (with Joshua Rauh), Review of Financial Studies, Vol. 26 No. 2
    Handle: RePEc:nbr:nberwo:17122

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    1. Epstein, Larry G. & Miao, Jianjun, 2003. "A two-person dynamic equilibrium under ambiguity," Journal of Economic Dynamics and Control, Elsevier, vol. 27(7), pages 1253-1288, May.
    2. Lerner, Joshua & Schoar, Antoinette, 2003. "The Illiquidity Puzzle: Theory and Evidence from Private Equity," Working papers 4378-02, Massachusetts Institute of Technology (MIT), Sloan School of Management.
    3. Steven Kaplan & Antoinette Schoar, 2003. "Private Equity Performance: Returns, Persistence and Capital," NBER Working Papers 9807, National Bureau of Economic Research, Inc.
    4. Norman Strong & Xinzhong Xu, 2003. "Understanding the Equity Home Bias: Evidence from Survey Data," The Review of Economics and Statistics, MIT Press, vol. 85(2), pages 307-312, May.
    5. Josh Lerner & Antoinette Schoar & Wan Wongsunwai, 2007. "Smart Institutions, Foolish Choices: The Limited Partner Performance Puzzle," Journal of Finance, American Finance Association, vol. 62(2), pages 731-764, 04.
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    Cited by:
    1. Robert Novy-Marx & Joshua D. Rauh, 2012. "Fiscal Imbalances and Borrowing Costs: Evidence from State Investment Losses," American Economic Journal: Economic Policy, American Economic Association, vol. 4(2), pages 182-213, May.
    2. Marco Da Rin & Thomas F. Hellmann & Manju Puri, 2011. "A survey of venture capital research," NBER Working Papers 17523, National Bureau of Economic Research, Inc.

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