In today’s Times newspaper, columnist Daniel Finkelstein refers to a woman called Annie Duke who was a highly successful professional poker player, and who has just written her second book about decision making. He saves the time of the non-poker playing reader by summarising the core insight he derived from her two books as “you can’t be certain of the outcome of your decisions in advance, since the result depends upon luck as well as skill. So the right test of a good decision is not whether it ends well but whether it is made in a disciplined fashion applying good judgment given the facts you know”. I consider this to be a sound basis for considering the performance of the private equity industry and decisions I have made in the past about new investments.
The British Private Equity and Venture Capital Association (the BVCA) publishes an annual performance measurement survey, getting responses from the majority of UK-based private equity fund managers representing hundreds of funds. The latest survey results covered the year to December 2019 and while much has happened in 2020, it is worth reflecting on the numbers that were reported.
The survey reports net of fees IRRs from member funds and finds three year, five-year and ten-year returns to be 18.5%, 20.1% and 14.2% respectively. These numbers comfortably outperform the FTSE All-Share index which returned 6.9%, 7.5% and 8.1% to investors over the same time periods. Covering 813 funds, the survey includes earlier stage venture funds, which represent a quarter of the total and it, is interesting to note that venture fund performance is on a par with private equity. This is a trend that has been seen in recent years.
The question is what will the 2020 numbers and beyond look like? Looking back to the Credit Crunch era, I reviewed some of the BVCA surveys from that time. The survey covering 2009 reported three year returns for the industry of 4.4% which, while outperforming quoted stocks, were impacted by the steep declines in valuations and losses of businesses to banks in the aftermath of several great boom years. By 2010, the three year performance data had increased only slightly to 6.7% but again outperforming public markets.
An interesting survey was produced by the BVCA and EY in 2010 that reported a 5% increase in the revenue of private equity owned portfolio companies and growth in employment compared with a 0.3% reduction in private sector employment.
These historic reports offer comfort that the industry will respond and portfolio company performance will continue to outperform the broader economy, stimulated by careful management by private equity owners.
Nevertheless, these are unprecedented times for our economy and the industry as a whole. The private equity industry has historically placed some emphasis on certain sectors that may see the greatest structural shifts (eg. consumer retail and hospitality) and therefore performance may suffer. Clearly portfolio management has become the focus of effort for private equity managers. The rate of new investments across the globe hitting a ten-year low during the second quarter of 2020 and in Europe, the first half of the year was the worst six-month period for new investments since 2009.
It is hoped that with the focus on existing portfolio, returns in the industry will continue their long-term trend of outperformance.