Traditional fund-level benchmarks are no longer sufficient for investors performing due diligence on private equity funds, according to research and advisory firm Cambridge Associates.
The Boston-based firm released a study on 9 February outlining a new type of investment-level comparison between funds that it said could add greater insight for investors, as private equity increasingly involves a variety of fund structures deviating from the traditional 2/20 fee model.
“Private market investments have expanded into many different sub-strategies and structures,” Cambridge senior investment director Rich Carson told pfm.
He explained that existing fund-level benchmarks compare various private equity funds based on their vintage year and net of any fees and other costs pocketed by the fund manager. For example, if an investor were performing due diligence on a 2015-vintage fund, the benchmark would show other funds raised in 2015 compared by net internal rates of return.
Now, however, the industry comprises co-investments, direct investments, sector-specific funds, secondaries-dedicated funds and even varied fee options – such as 1/30 or 3/20 instead of 2/20 – in the traditional commingled structures. These complications, Carson said, make the fund-level benchmark less of a reliably direct comparison.
“All these things have an effect of making these benchmarks based on fund-level vintage year just not always sufficient to help an investor understand the full story of how managers create value,” Carson said.
Cambridge has a database composed of 6,700 private equity and venture capital funds and 75,000 investments from those funds. Using this dataset, it captures investment-level comparisons that show a fund’s specific investment performance, gross of returns. Carson said gross performance metrics account for the variability in different fee structures that could affect true comparisons among net returns.
The investment-level benchmark measures direct and co-investment performance, gross of fees; sector, strategy or region-specific performance by pooling all investments made in a specific sector rather than looking at the whole funds; and performance focused on investments made in the same calendar year, rather than funds’ vintage years, according to the Cambridge report.
“We’re not saying the traditional fund-level benchmarks are not useful,” Carson said. “We’re saying they’re not as useful in some cases, like co- and direct investments. In those cases, the investment-level benchmark is complementary to the fund-level benchmark.”