Private Equity in the 21st Century: Cash Flows, Performance, and Contract Terms from 1984-2010
Using detailed quarterly cash flow data for a large sample of private equity funds from 1984-2010, we examine cross-sectional and time-series cash flow performance of private equity funds across a range of asset classes, including venture capital, buyout, real estate, distressed debt, and funds-of-funds. Our data also include key features of the management contracts, specifically carried interest, management fees, and general partner capital commitments, allowing us to investigate the determinants of contractual terms and to link contractual terms to performance. The data reveal important facts about the private equity market in the 21st century. On average, our sample pri-vate equity funds have outperformed the S&P 500 on a net-of-fee basis by about 15%, or about 1.5% per year. Performance varies considerably across fund types and over time. Larger funds require larger percentage capital commitments from the general partners (GPs), consistent with concerns about GP incentives in large funds. Larger funds also charge lower management fees, and obtain higher carried interest, consistent with learning about GP ability. Management fees, but not carried interest, are higher during fundraising boom periods, even controlling for fund size, suggesting that the fixed/variable mix of GP compensation shifts toward fixed components during fundraising booms, consistent with increased GP bargaining power in booms. In marked contrast to the mutual fund literature, there is no relation between management fee and carry terms and net-of-fee performance, suggesting that GPs with higher fees earn them in the form of higher gross-of-fee performance. There is some evidence that funds with lower GP capital commitments outperform. Conclusions about private equity performance over time differ markedly depending on whether performance is measured in absolute terms (IRR) or adjusted for the performance of the S&P 500 (PME). In particular, funds raised during hot markets underperform in terms of IRR, but not in terms of PME. Capital calls and distributions are both more likely and larger when public equity valuations rise and when liquidity conditions tighten. During the financial crisis and ensuing recession of 2007-2009, the component of calls unexplained by macroeconomic factors spiked, distributions plummeted, and the sensitivity of calls and distributions to underlying macroeconomic conditions changed considerably.
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