Using a variety of measures, the authors calculate the investment performance of private equity (PE) funds, as defined by buyout (BO) and venture capital (VC) fund subsamples, during the 2008 financial crisis. The authors document PE fund outperformance against applicable indexes, finding a strong size effect that they attribute to BO funds. They interpret PE returns as being driven by fund management experience and identify maximum efficient fund sizes. They estimate the effects of fund duration and the timing of capital deployment into investments. Finally, the authors judge the beta values against the S&P 500 Index to be low, with returns derived from operational improvements.

Given the customary life cycle and pattern of returns of PE funds (10-year duration and a J-curve payout trend in which returns stay negative until a payback point of distributions equaling contributions is reached), the authors note that their study was done at about the earliest possible time to accurately gauge the effects of the 2008 crash on funds that were active at the time. With a fairly pronounced long-term trend of a growing share of institutional investment assets being allocated to the alternative category (with PE being one of its prominent segments), an improved understanding of related return characteristics over a full financial cycle would benefit investor decision making.

The authors’ analysis presents a variety of distinct advances to current knowledge, including the following:

• Confirmation that a performance measure designed particularly for PE funds—the public market equivalent (PME)—offers an appraisal best suited to the evaluative needs of limited partners (i.e., investors buying into funds), especially when based on comparisons with the S&P SmallCap 600 Index.
• PE is shown to have substantially outperformed the public market throughout the financial crisis by achieving consistently superior returns.
• Although size and experience produce particularly important effects, they are implicated differently across the studied subsamples. Expert fund managers with the ability to select portfolio companies and enhance their growth can apply their experience most profitably at a BO fund, but a relatively large VC fund enjoys extra advantages.
• Under adverse conditions, keeping one’s powder dry by being more selective as investment opportunities shrink proves most rewarding.

The authors study the Preqin cash flow database of 358 US PE funds (177 VC and 181 BO) with vintage years (i.e., starting points) spanning 2002–2007. Each fund’s calls and distributions and associated transaction dates are included—collected from general partners and public filings of pension fund investors. The authors use Morningstar data for the S&P 500 and the S&P SmallCap 600 to frame the PME calculation. Their analysis focuses on BO and VC funds split evenly between both categories. The authors measure performance on both an equal-weighted basis and a size-weighted basis; they judge value creation by using the internal rate of return, money multiple (total value to paid-in), and PME measures. They find that the annual outperformance of VC and BO funds is 694 bps and 1,158 bps, respectively.

The other research question the authors focus on is PE return causation. They run ordinary least squares (OLS) regressions that predict PME by fund size and sequence, complemented by adding dummy variables (“VC” to assess the relative performance of VC and BO funds, and “drawdowns” to model investment flows). They use separate regressions to analyze each vintage year and for subsamples of fund types. They monitor the concavity (convexity) of the relationship between fund performance and size (sequence). They compare their results with those of previous PE studies to gauge the impact of the financial crisis. Using the Macaulay formula, they model fund duration to check cash flow timing effects. Finally, they estimate fund betas to be less than 1 for PE overall and for both BO and VC funds (statistically significant at the 1% level). They interpret this result as showing that PE’s performance is understated by PME on a risk-adjusted basis—in other words, PE’s performance was even more positive during the crisis given the heightened risk.

The authors’ thorough analysis presents compelling evidence for the distinct benefits of a PE allocation, particularly in an adverse and volatile investment environment. For a balanced view of their findings, some additional considerations, while not signs of fatal research flaws, would likely be useful. First, both authors are PE professionals, with the lead researcher, on academic fellowship leave as of the date of publication, failing to disclose his status as a venture capitalist. So, there could be an incentive to represent PE investing favorably. Second, compiling an exhaustive census of all active PE firms can be quite challenging given the easy entry and possible operation “under the radar,” outside a monitored population of self-reporting firms—which could skew calculated returns. Third, the crisis could introduce unique effects given its financial character. During the crisis, new firms experienced a prolonged closure of funding windows. So, PE portfolio companies with access to already committed capital via pre-crisis vintage funds could have enjoyed a differential resource advantage compared with their unendowed peers, thus buttressing profitability.