Private Equity Performance and Liquidity Risk

Abstract

Private equity has traditionally been thought to provide diversification benefits. However, these benefits may be lower than anticipated as we find that private equity suffers from significant exposure to the same liquidity risk factor as public equity and other alternative asset classes. The unconditional liquidity risk premium is about 3% annually and, in a four‐factor model, the inclusion of this liquidity risk premium reduces alpha to zero. In addition, we provide evidence that the link between private equity returns and overall market liquidity occurs via a funding liquidity channel.

Estimating Private Equity Returns from Limited Partner Cash Flows

“…The primary contribution of this paper is the introduction of a methodology based on Bayesian Markov Chain Monte Carlo (MCMC) to estimate a time series of PE returns using cash flows accruing to limited partners and factor returns from public capital markets. The identification strategy of this methodology is similar to that of Cochrane (2005), Korteweg and Sorensen (2010), Driessen, Lin, and Phalippou (2012), Franzoni, Nowak, and Phalippou (2012), and Korteweg and Nagel (2016). Our contribution with respect to prior research is that, in addition to estimating factor loadings and αs, we are able to construct a quarterly time series of returns that is useful for understanding the intertemporal behavior of the asset class.…”

Investment beliefs of endowments

“…We find that expectations about private equity alpha have increased over the past 7 years and, as of fiscal year end 2012 they represented a 3.9% annual premium. This roughly corresponds to the illiquidity premium estimated by Franzoni, Nowak, and Phalippou (2012), the private equity return differential over the S&P 500 reported by Harris, Jenkinson, and Kaplan (2014), and the differences in geometric means between the widely used industry benchmark Cambridge Associates US Private Equity Index and the S&P 500. It is higher than estimates of alpha delivered by private equity investments for which alpha is defined as the residual component of return not explained by exposure to a multi-factor equity benchmark that includes small cap, value, and liquidity factors.…”

Sensitivity of generalized translog model estimates to alternative Pythagorean means: Evidence from US healthcare

“…Another way is to consider the geometric mean as the antilog of the mean of the logged data. This conceptual measure is extensively employed in financial studies to account for nonconstant and compounding rates of change (Doidge, Karolyi, & Stulz, 2010;Franzoni, Nowak, & Phalippou, 2012). It is a good measure of central tendency for lognormally distributed samples and skewed data distribution (Dytham, 2011).…”