Metrics 2.0

In an industry where everyone is top quartile, it’s hard to know how valid performance measures really are. At a breakfast panel hosted by Broadgate Consultants, LPs and advisors discussed some of the challenges in performance benchmarking, and made their recommendations on what the industry needs. While they were of several minds on just how much transparency is feasible, or even desirable, everyone agreed that more objectivity is needed.
“There’s a need and an opportunity to improve things,” said Dr. Oliver Gottschalg, an assistant professor of strategy and business policy at HEC School of Management, as well as a co-director at HEC-INSEAD Buyout Research Group. He envisions an evolution toward broader, more reliable and more objective performance standards to eliminate inefficiencies in the market that prolong the process of matching LPs to GPs.
Although he admits that measures like internal rates of return and return multiples may never capture all the information about a fund’s performance, there are factors which could be measured with some uniformity across the industry. The speed and pace at which GPs deploy capital, the regularity with which GPs find deals, and the frequency with which GPs are able to accurately time the market were some of his examples.
But Jesse Reyes, a managing director at Bear Stearns Private Funds Group, disagreed with his recommendations, pointing out that inefficiencies are what drive profits in the private equity industry. “It’s a little bit like the goose that laid the golden egg,” he said, “You open up the goose to find out where the gold is coming from, and guess what: no more gold.”
Reyes analogized measuring a firm’s performance to the days when scientific metrics were first applied to analyzing cotton quality.
Although investors knew a lot more about the characteristics of the cotton, prices continued to be volatile. And in financial markets, the objectivity people strive for in measuring performance, the more they will realize how difficult it is to find an apples to apples comparison between firms.
“The more granular you get, the more you try to dissect what makes you better than someone else, the more difficult it’s going to be.” Scott Hamner, a partner at Credit Suisse Customized Fund Investment Group and the third member of the panel, said that while he doesn’t discount the mathematical approach entirely, he is unsure of how much he could learn from numbers alone. Is a fast and regular investment pace always a good thing? he asked.
Gottschalg conceded that judgment is an important element of measuring performance, but stressed that until there is more transparency in the industry, the big players will continue to reap “extraordinary” returns at the expense of the smaller firms. When the aindustry has adopted better measures of value, performance measurement “will remain an art, but an art that will be built on a much more solid basis.”