There is a prevailing perception – especially among limited partners — that staff turnover is a bad thing. And for good reason: LPs expect the investment professionals to whom they entrust their capital will stick around to make sure their investments are successful.
Seems like common sense. However, research from Capital Dynamics and the London Business School appears to be turning that prevailing wisdom on its head.
It's a topic PE Manager has covered in the past, which led to a conclusion that team stability is in fact no holy grail for performance.
The report, which looked at staff turnover and performance at both fund and deal level, found teams which experienced turnover from one fundraising to the next performed better in their next fund. For turnover at fund level, the report looked at the entire firm, except for the back office. They found that a 1 percent increase in turnover led to a 10 percent increase in subsequent net internal rate of return (IRR).
The study, which averaged net IRR across funds with the highest and lowest terciles of turnover, also found that funds with the highest turnover produced a 25 percent net IRR on average, while funds with the lowest turnover had an average IRR of 11.5 percent.
The results are a surprise, because turnover has always been a bad word and stability was seen as a good thing in many people’s mind
The report looked at 145 managers globally using information from Capital Dynamics’ due diligence database. The study analyzed the backgrounds and investments of management teams together with corresponding deal and fund performance attributed over a 20-year period, between 1990 and 2011.
“The results are a surprise, because turnover has always been a bad word and stability was seen as a good thing in many people’s minds,” Kairat Perembetov, a vice president at Capital Dynamics, told PE Manager.
The authors also looked at turnover during the investment period, but those results were inconclusive. Additionally, staff turnover at deal level, which included all the investment professionals involved in a deal, was linked to weaker performance, according to the report. Stable deal teams produced a gross IRR of 32 percent, compared to a 20 percent gross IRR for teams with turnover. The study was however unable to draw any conclusions from this.
“Some deals had stable teams because the deal was successful and that may have been the reason why people didn’t leave. Some deals just weren’t successful and people may have left because of the potential bad track record, so we therefore can’t say that stability was the main source of the performance,” Perembetov said.
The study also broke down the turnover by dividing all professionals into three groups, based on their previous experience: operational, financial and private equity. The operational group had experience in running operations, the financial group mainly had experience in banking and the private equity group had prior experience in private equity.
Additionally, higher turnover of professionals with operational backgrounds led to a significant improvement in performance, the report found.
Between funds, the higher turnover of professionals with private equity backgrounds resulted in a drop in performance, proving that having professionals with private equity backgrounds is critical for a good performance. Succession planning for these team members is therefore “very important”, according to the study. Yet turnover of team members with banking backgrounds had little impact on returns. “Financial skills appear to be a commodity,” the report concluded.
Teams that evolve and change their operational skills are those teams that will be the future winners, Perembetov said. “The LPs that do due diligence shouldn’t only be looking at the team stability as a good thing. They should look more in detail at what happened to the team; if someone is leaving they should look at the background of the person who is leaving and [look at which person with what type of skills set has left],” he said.