It’s About Time: Duration Matters

By: Christopher Bass, Avi Turetsky, Barry Griffiths

Over the past two decades, institutional investors have exhibited an increasing appetite for private equity investments. Private equity offers several advantages, including strong historical returns and potential exposure to alpha-generating managers. However, private equity has the disadvantages of illiquidity and the related lack of transparency in performance assessment.

Illiquidity is a problem for private equity investors for several reasons. First, and most obvious, there might come a time when an investor would rather have cash than an interest in a private partnership. More generally, when a private equity fund is illiquid for a long time, an investor doesn’t have the option to rebalance the portfolio or to change managers. Investors in publicly-traded securities take these options for granted, while private equity investors must carefully consider what these options are worth.

In this white paper, we measure illiquidity in terms of duration. Duration is defined for private equity the same way it is for bonds. It’s the time the average dollar is invested, as opposed to the contractual life of a fund.

One complication is that the term “private equity” encompasses a range of strategies, including but not limited to venture-funded startups, leveraged buyouts and diversified fund of funds. Performance and duration vary from strategy to strategy. An investor who chooses to invest in funds with long expected durations needs to be confident the return will compensate for the foregone option to change his or her mind.

We examine recent historical performance, in terms of return and duration, of several distinct private equity strategies: secondaries, primary fund of funds, leveraged buyouts, distressed debt, mezzanine debt and venture capital. Of these strategies, we find that leveraged buyouts and secondaries have performed similarly with the highest average net internal rate of return (IRR) performance. Although both strategies perform similarly with regard to net IRR, secondaries, as a subclass, is uniquely appealing since an investor simultaneously achieves an equivalent rate of return and retains the most optionality for subsequent decision-making as measured by duration.

The above is a brief synopsis of the white paper referenced in the title. It is not itself a complete record of that paper and cannot be relied upon in isolation. A copy of the full white paper is available upon request.

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