Biases in Private Equity Returns

Seminar abstract

Private Equity (PE) has grown into a substantial asset class, but there remain major problems with measuring PE fund returns. Investors continue to use the internal rate of return (IRR) as a key measure of fund performance. It is well known that early returns of cash can have a substantial impact on fund IRRs, but the magnitude and causes of this effect have not previously been systematically analysed. We demonstrate that the IRR is affected by two biases: a convexity bias, and a “quit-whilst-ahead” bias arising because the returns on PE projects tend to covary with their durations. Both bias the IRRs of PE funds upwards. Using a range of parametric and non-parametric estimation techniques, we show that these biases boost fund IRRs by an average of around 3% per annum - a very significant proportion of the average net PE fund IRR (around 12% per annum). Fund cash multiples and PMEs become similarly biased if they are annualized to try to make them comparable with other assets. We further demonstrate that alternative performance measures which have been suggested by practitioners are also biased, which confirms how poorly understood these effects are. Failure to take proper account of these biases is likely to lead investors into badly misinformed investment decisions.

How to attend this seminar

This seminar is free to attend with no need to register in advance.

We welcome you to join us online on Wednesday 14 December 2022 at 2pm.

For details on how to join online please contact Dr Anna Sarkisyan

Speaker bio

Dr Simon Hayley

Simon Hayley’s research at Bayes Business School (formerly Cass) has concentrated on investor behaviour and the misconceptions that sometimes drive it, in particular the use of misleading performance metrics. This research has been published in leading global journals, including the Journal of Financial and Quantitative Analysis. Based on his teaching, he wrote "Economics: A Primer" (Oxford University Press, 2018) with Alec Chrystal. Before moving to Bayes, Dr Hayley had a career covering policy analysis for government and market analysis for a range of city institutions. He worked as, successively, a currency strategist, a currency overlay manager and a global market analyst. Prior to this, he worked as an economic forecaster at the Reserve Bank of New Zealand and as an economic adviser at HM Treasury, covering a variety of areas including macroeconomic modelling and forecasting, evaluating microeconomic policy effectiveness, market analysis and UK policy towards EMU.