With a glut of funds already raised, and even more in the pipeline, private equity investors have been inundated with pitches from general partners (GPs).
But when the economy is shaky, it’s difficult for limited partners (LPs) to determine which new funds will succeed and therefore they should invest in.
Oliver Gottschalg, a professor at HEC Paris, has carried out research that might help LPs decide.
“The context of this [research] was a desire to figure out empirically how we can get guidance on the attributes of a GP who would be more likely to be a safe pair of hands in a downturn,” Gottschalg told Private Equity News.
Marketing materials explicitly state that past performance does not guarantee future returns. But Gottschalg found that a GP’s track record during an economic downturn can make all the difference between the success and failure of a future fund.
Gottschalg analysed nearly 12,500 buyouts executed between 1990 and 2015 by almost 200 general partners to identify deals were impacted by a difficult environment including those in poorly performing sectors.
“It matters whose hands you have that deal in,” he said. “That substantially influences the likelihood of the transaction becoming a success.”
Gottschalg’s research found that more than a third of all realised private equity deals have downturn characteristics – when the return from the investment is not high enough to pay the cost of capital. In two thirds of these deals, the GP was able to achieve success at exit, becoming what he dubs as “downturn successes”.
He then assigned a downturn success ratio to GPs, which measures the degree to which a fund manager had experience with downturn deals in the past and how frequently these deals still had successful outcomes.
GPs with a below-average downturn success ratio are twice as likely to have a future fund in the bottom quartile in terms of performance, than GPs with an above-average downturn success ratio, Gottschalg found.
In contrast, GPs with high past downturn success ratios are more likely to deal better with downturns in the next fund, according to the data.
“Private equity isn’t only theoretically better to deal with tough times, GPs are doing a good job encountering difficult situations and still are able to succeed.
They can keep working the deal and are incentivised to work to make it a success,” he added.
Source: PE News
