Private equity is currently replacing hedge funds as the most observed asset class. And while mutual funds experience a decline of assets under management, buyout funds break all records as far as fund raising is concerned. The attractiveness of buyout funds among investors is often attributed to superior returns and to an allegedly lower correlation with other asset classes. However, buyout fund returns also show superior volatility. In addition to that risk factor, investors must face liquidity and transparency risk. It is common agreement that investors are compensated for the elevated risk through a return premium. This and the cited lower correlation prompt more and more investors to add private equity into their portfolios. The wide-spread opinion of superior private equity performance is backed by several studies. But the analysis of these studies reveal that a number of them employ methodologies which are disapproved of by experts on theoretical private equity performance measurement. Furthermore, some have a one-sided notion of financial performance. Benchmarking, risk and correlation data which are crucial for an overall performance assessment often lack. The analysis of a series of technically appropriate, objective studies shows that private equity has historically outperformed public equity with regard to returns, in Europe more than in the United States (US). What remains unsolved is to which extent this return premium rewards the inherent, additional risk of private equity investments. And what is more certain: the prevalent view on correlation seems to be wrong. Empirical evidence and qualitative analysis speak for high correlation between private equity and the major asset classes. The most important driver for individual fund performance appears to be the quality of fund management. Thereby, specialized teams outperform others. Moreover, specialized funds provide investors better opportunity to diversify their private equity portfolio. Fundraising and investment conditions for private equity funds in France and Germany are favorable, but the accomplishment of superior performance will become harder in the future. The rules of the private equity business are changing as operating leverage has replaced financial leverage as the essential value driver.
1. Introduction
1.1. Motivation
1.2. Objectives
2. Private Equity – An Overview
2.1. What is Private Equity?
2.2. What is a Leveraged Buyout?
2.3. Limited Partner
2.4. General Partner
2.5. Target Company
2.6. Financing of Leveraged Buyouts
2.6.1. Equity
2.6.2. Debt
2.6.3. Mezzanine
2.7. Exit Channels
2.8. The Three Levers for Value Creation in Leveraged Buyouts
2.8.1 Financial Leverage
2.8.2. Operating Leverage
2.8.3. Market Timing / Exit Multiple
3. Performance Measurement of Private Equity
3.1. General Financial Performance Measurement Theory
3.2. Performance of the Asset Class Private Equity
3.2.1. Performance Measurement Theory
3.2.2. Performance Measurement Practice
3.2.3. Recent Study Results
3.2.4. Implications
3.3. Performance of Individual Private Equity Funds
3.3.1. Performance Measurement Theory
3.3.2. Recent Study Results
3.3.3. Implications
4. Macroeconomic Environment for Private Equity in Germany and France
4.1. History of the Private Equity Markets
4.2. Legal and Fiscal Environment
4.3. Fund Raising
4.4. Debt Financing
4.5. Investment Opportunities
4.6. Competition within Private Equity
4.7. Business Markets and Perspectives
4.8. Exit Channels
4.9. Conclusion – Exploitability of the Three Value-Creating Levers
5. Conclusion
5.1. Performance of Private Equity Funds
5.2. Outlook on the Perspectives of Private Equity Performance
5.3. Hypotheses and Recommendations for Further Research
Objectives and Thematic Focus
The primary objective of this thesis is to assess the performance of private equity funds from both a theoretical and practical perspective. The work investigates whether private equity delivers superior risk-adjusted returns compared to other asset classes, explores the drivers of these returns, and evaluates the impact of the macroeconomic environment in Germany and France on the future success of these investments.
- Methodologies for measuring private equity performance and their associated limitations.
- The value-creation mechanism in leveraged buyouts, specifically financial leverage, operating leverage, and market timing.
- Historical performance analysis of private equity as an asset class compared to public markets.
- Success factors for individual funds and the importance of professional fund management and specialization.
- Macroeconomic conditions and exit environments for private equity in Germany and France.
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2.8. The Three Levers for Value Creation in Leveraged Buyouts
In the following, the three levers which can be triggered to increase the value of the target company during the investment period are described. Their relative importance has changed from the earliest buyouts until today. Today, financial leverage can be easily arranged. The markets for highly risked debt are well developed and financing alternatives are abundant. Access to this funding is no longer exclusive and a buyout fund only relying on financial leverage would not be able to offer a competitive price in the bidding process for a target. Its investment opportunities would be restricted to cases of exclusive deal sourcing. Strong knowledge of the target market and business which permits implementing changes in the way the company is run, as well as obtaining an attractive exit multiple are the two other important value drivers. The financial lever has historically accounted for around 50% of the value creation in LBOs. Today, its impact is estimated to be 25%. The importance of the exit multiple has increased to 20%. The most influential value driver determining 55% of the value appreciation, however, is the internal value creation within the target company through growth of the business and improvement of operations.
Summary of Chapters
1. Introduction: This chapter provides the motivation for the study, highlighting the growing popularity of private equity, and defines the research objectives regarding performance and drivers.
2. Private Equity – An Overview: This section introduces the private equity business model, explains the mechanics of a leveraged buyout, and details the three primary levers used for value creation.
3. Performance Measurement of Private Equity: This core section evaluates investment performance measurement theory, analyzes various studies on the asset class and individual funds, and discusses the challenges of data reliability.
4. Macroeconomic Environment for Private Equity in Germany and France: This chapter assesses the specific market conditions, including legal and fiscal frameworks, fundraising, and investment opportunities in Germany and France.
5. Conclusion: The final chapter summarizes findings on performance, provides an outlook on future perspectives, and suggests hypotheses for further research.
Keywords
Private Equity, Leveraged Buyout, Performance Measurement, Value Creation, Financial Leverage, Operating Leverage, Asset Allocation, Risk-Adjusted Return, Limited Partner, General Partner, Buyout Funds, Market Timing, Germany, France, Investment Management.
Frequently Asked Questions
What is the core focus of this thesis?
The work focuses on analyzing the performance of private equity funds, specifically assessing their risk-adjusted returns and identifying the key drivers that contribute to value creation for investors.
What are the primary themes discussed in this document?
The document covers the business model of private equity, performance measurement methodologies, the history and current state of the industry in Germany and France, and the specific impact of value-creation levers.
What is the main research objective of this work?
The main objective is to evaluate private equity performance theoretically and practically, providing investors and executives with insights into whether the asset class truly delivers the promised return premium.
Which scientific methods are applied in this research?
The research relies on an extensive review of existing financial studies, trade journals, and data from industry associations, applying comparative and critical analysis to evaluate the validity of findings from various sources.
What is addressed in the main part of the thesis?
The main part analyzes the functioning of leveraged buyouts, evaluates diverse theories and practices of performance measurement, and performs a comparative assessment of the macroeconomic conditions in the German and French private equity markets.
How would you characterize the work using keywords?
Key terms include private equity, leveraged buyout, performance measurement, value creation, and asset allocation, reflecting its nature as a financial and strategic study.
Why are standard IRR metrics often criticized in the context of private equity?
IRR metrics are criticized because they are sensitive to the timing of cash flows and often rely on interim valuations (NAVs) which can be subject to bias, making direct comparisons with public market indices difficult.
How does this document evaluate the performance of the German and French markets?
The document evaluates these markets through the lens of legal and fiscal attractiveness, competition for deals, and the ability of funds to trigger value-creation levers given the specific industrial and economic landscapes of both countries.
- Quote paper
- Taro Niggemann (Author), 2005, Performance of Private Equity Funds, Munich, GRIN Verlag, https://www.grin.com/document/44362
