PE academic responds to study criticisms

A study finding private equity managers generate alpha is true to mark, regardless of some biases in its methodology, said Oliver Gottschalg of the HEC School of Management.

A private equity study criticised for flawed market analysis has defended its findings despite admitting to biases in its data set.

The study, conducted by German fund of funds manager Golding Capital Partners and Oliver Gottschalg of Paris-based HEC School of Management, found that private equity investments from “established” managers generate an average excess return of 5 percent compared with public market investments. The study also stated that private equity investments outperform comparable public market investments to a greater degree during “difficult market phases…when companies are in greatest need of support”.

Golding Capital Partners’ transaction database encompasses principally Europe and the US between 1977 and 2010. 

The study was criticised by some media outlets for not including in its data set managers that tried and failed to raise private equity funds, and for ignoring factors such as “risk, liquidity and a market structure which often gifts big names sweet-priced deals”. These criticisms, however, are not contested by Gottschalg, who helped conduct the study. 

“This data set is by no means an unbiased data set,” Gottschalg told PE Manager, referencing the fact that the sample of over 4,200 deals were completed by only ‘established’ fund managers. “The second upward bias comes from the fact that we have to restrict ourselves to the realised transactions.” 

When analysing the impact of cyclicality, however, using net asset values for unrealised portfolios would “introduce huge distortions in our data,” Gottschalg said. “This is not a study meant to answer the question, ‘How does private equity perform on the average?’ This is a study meant to answer the question, ‘How does private equity performance vary across economic cycles’”. 

Specifically, the study tries to “understand how the performance of a realised deal compares to stock market movement over its holding period”, Gottschalg said. “The interesting finding is that we can show that during a downturn, very systematically private equity delivers alpha.”

While it is easy to see why biases in the data set might attract criticism of the study, many investors continue to overlook the fundamental differences between private equity and the public market that make unbiased analysis virtually impossible, Gottschalg said.

“You wouldn’t believe the number of [investors] who come to me and say ‘We need to somehow benchmark PE. We need to put them in our risk model for Solvency II or Basel III.’” he said. “Those risk models make assumptions that private equity violates, and I can’t fix that problem. That’s just the nature of the beast.”