The performance of private equity

How returns developed

Scientific Essay, 2010

13 Pages


Table of contents

1. Development of the private equity market volume

2. Situation of the private equity market in 2009-10

3. The performance [= “return”] of private equity

4. Features of the returns of private equity funds

5. Conclusion: Risk structure of private equity

1. Development of the private equity market volume

The European private equity market has achieved a considerable volume of USD 116 bn. in 2006; still, however, the US American market with a volume of USD 187 bn. was considerably larger. The average size of the private equity transactions in Europe has, however, hardly increased over time.

This can be traced back, among other things, to the fact that until now there have hardly been major transactions (so-called megadeals) comparable to those in the USA.

Figure 1: Equity capital raised by the 15 largest PE companies[1]

illustration not visible in this excerpt

Reasons for increasing the volume can be seen in the favourable economic development, low inflation and strong competitive pressure on the part of financial intermediaries. These led to falling swap spreads on the financial markets and increased the investors’ risk tolerance.

The private equity companies were able to observe high inflows of funds for the funds they launched and thus lay the basis for rapid market growth. At the peak, some Anglo-American private equity companies succeeded since 2005 in collecting equity totalling significant double-digit billions of US dollars.

As a result, new possibilities have arisen for the structured borrowing of equity and outside capital; these financing forms are typically based on an increased use of the leverage effect of the outside capital.

These developments have also led to companies being better able to adapt their level of debt to their expected cash flows and thus ultimately to take on a higher level of debt.

2. Situation of the private equity market in 2009-10

In September 2009 the German investment business was depressed. The dreariness in the business with company participations or buy-outs could already clearly be read in the half-year figures on the German market. The consultancy Ernst & Young counted only 54 transactions in the first six months in this country, one third less than in the second half-year of the previous year, which was already shaped by the financial crisis.

The amounts invested also declined by just over one third to EUR 2.8 billion, and this value was only achieved because the Ernst & Young experts booked the entry of the sovereign wealth fund from Abu Dhabi with 9.1 percent at the automotive manufacturer Daimler as a private equity transaction.[2]

From the record value of the second half of the year in 2006, when investment companies in Germany invested about EUR 30 billion in takeovers, the industry has in the meanwhile slipped again to the 2002 level. An improvement does not seem to be in sight.

Figure 2: Private equity transactions 2002-2008

illustration not visible in this excerpt

In light of the still meager bank loans, the private equity industry is compelled to put their traditional business models to the test. Making their move now are only financial investors who can execute their transactions despite a high share of equity, as the times of business with strong leverage effects through a high level of debt are over, into the foreseeable future.

Since 2002 the number of transactions increased steadily and strongly, experiencing a short drop at the end of 2006 and beginning of 2007 and then recovering again in 2008. In terms of value, however, transactions are in decline. The investors carried out primarily smaller transactions in late 2007 and early 2008.

3. The performance [= “return”] of private equity

At the end of the 1990’s the first private equity umbrella funds were set up for private investors. By combining the investments of numerous private investors, the high mini-mum investment sums can be overcome. While in other countries, pension funds in particular have long been investing in this investment category, private equity has be-come more well-known in Germany only in the past ten years.[3]

Due to this lack of awareness, private equity is still frequently associated with high risk.

On the one hand it is mistakenly equated with venture capital. The financing of young start-up companies, however, – as already described – represents only a sub-area of the private equity investment categories.

On the other hand, when assessing risk, general statements are often made without differentiating among the risk profiles of the individual investment forms – direct in-vestment, funds and fund-of-funds.

Investing in an individual company can sometimes be fraught with risk. Since private equity funds work in a highly specialised way and concentrate on specific sectors or industries, the investment in a single private equity fund can also be risky.

The risk of default of an umbrella fund with investments in approx. 20 or more target funds, however, is very low due to broad diversification. While additional costs are incurred for the investor for the services provided by the umbrella fund (fund selection, liquidity management, investment controlling, administration), the expected return is still clearly double-digit, even after subtracting these costs. Private equity umbrella funds achieve a capital increase of 1.5 to 2 times greater with a probability of 70%.

The investments of investors in private equity funds or private equity companies are thus often diversified in accordance with a security-oriented balanced portfolio concept across various reasons for financing (e.g., 40-45% buyout, 30% mezzanine, 25-30% venture), regions (e.g., Europe, USA, Asia) and launch years.

Though the returns of a balanced private equity portfolio cannot compete with the dream returns of successful venture capital funds of between 50 and 70% per year, the probability of default is, however, very low, in fact almost zero. The average expected return for a period under consideration of ten years and longer is approx. 14-17% per year. In the year 2006 alone, American funds achieved average returns of 26.7%.


[1] Cf. Deutsche Bundesbank (2007, p. 19). Monatsbericht April 2007. Leveraged-Buyout-Transaktionen, die Rolle von Finanzintermediären und Aspekte der Finanzstabilität.

[2] Cf. Paul, FAZ (09/2009). Das deutsche Beteiligungsgeschäft liegt danieder.

[3] Cf. Abakus (2007). Beteiligungsformen.

Excerpt out of 13 pages


The performance of private equity
How returns developed
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ISBN (eBook)
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private equity, performance, fund, investor, fund-of-funds, M&A
Quote paper
Jörg Eschmann (Author), 2010, The performance of private equity, Munich, GRIN Verlag,


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