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Venture Capital and Its Role in Strategic Asset Allocation
Abstract
With record amounts of money flowing into venture capital investment in recent years, it has become an important asset class in many long-term strategic portfolios. The authors explain the long-term risk-return characteristics of venture capital investment and its role in a long-term strategic asset allocation. While there are limited market performance data on venture capital, they find that from 1960 through 1999, venture capital has had an annual arithmetic average return of 45% with a standard deviation of 115.6%. The geometric average return (compounded average) is estimated to be about 13%. The correlation coefficient between venture capital and public stocks is estimated to be 0.04%. Because of its relatively low correlation with stocks, an allocation to venture capital of 2% to 9% is warranted for an aggressive portfolio (i.e., all-equity).
... For example, Cochrane, 2000, Quigley and Woodward, 2003 and Hwang, Quigley and Woodward, 2005, infer aggregate information about the performance of private equity investing using data on the returns to individual venture capital projects. Peng, 2001, Chen, Baeirl and Kaplan, 2002, Woodward and Hall, 2004, and Hwang, Quigley and Woodward, 2005 use a repeat valuation model to construct an index of venture capital from which overall industry performance may be inferred. A problem with these studies is that they do not take into account the timing of the cash flows or the risk profile of the investing companies. ...
... One possible approach to answering this question would be to replicate the hypothetical fund analysis of the previous section using a venture industry index in place of the S&P500 or NASDAQ indexes. While a number of attempts have been made to construct venture capital investment indices (see Peng, 2001, Chen, Baeirl and Kaplan, 2002, Woodward and Hall, 2003, and Hwang, Quigley and Woodward, 2003), our analysis will focus on the Woodward and Hall (2004) 'Sandhill' index, which is available over the period December, 1988 to the end of the sample period. ...
In this paper, the investment performance of a large database of venture funds is considered over a 28 year period. The results suggest that a portfolio of venture capital partnerships can provide an average return that is superior to the public equity market, although the individual fund returns are highly positively skewed. Absent these outliers, the level of fund performance is more in line with public equity market returns. This paper also establishes a link between public equity market conditions and venture capital returns. Finally, some preliminary evidence is provided of venture fund performance during and immediately following the dot.com bubble.
... Also Chen et al. (2002), Kaplan and Schoar (2005), Cumming and Walz (2004), Gompers and Lerner (1997) or Ljungqvist and Richardson (2003) analyze the high rates of return of the venture capital investments. The volatility of venture capital performance has been studied by Moskowitz and Vissing-Jorgenson (2002), Cheng et al. (2002) or Long (1999). Cochrane (2005) shows that the investment risk decreases from one financing round to the next. ...
... Databases such as VentureOne or VentureXpert are built on the cash flow information voluntarily reported by the venture capital investors. Studies like Cheng et al. (2002) or Cochrane (2005) suggest certain measures to adjust some of those biases. ...
This paper is focused on venture capital shareholding in companies with high uncertainty due to their sector, the stage of their activities or owing to the lack of historical data. In particular, we explain the problem of early shareholding disinvestment, analyzing the way asymmetric information becomes the key element of the value of above-mentioned possibility. We employ real option methodology to the implementation of the analysis assuming three different hypotheses.
... Most institutional investors aim for a specific private equity exposure as part of their strategic asset allocation. To the best of our knowledge, prior studies on optimal strategic asset allocation, like Chen et al. (2002), ignore the illiquid nature of private equity. The illiquidity is due to the lack of a well-developed secondary market and to restrictions on the sale of private equity fund investments, see Sahlman (1990) and Lerner and Schoar (2004) for a discussion. 1 ...
... 3 A possible motivation to include private equity in an investment portfolio is provided by its risk and return characteristics. These have been studied extensively (i) at the firm level (Gompers and Lerner, 1998;Cochrane, 2005), (ii) at the fund level (Ljungqvist and Richardson, 2003a;Kaplan and Schoar, 2005;Phalippou and Gottschalg, 2007) and (iii) at the index level (Moskowitz and Vissing-Jorgensen, 2002;Chen et al., 2002;Woodward and Hall, 2003). An important issue here concerns the private equity risk premium, in particular its comparison with the public equity premium. ...
This dissertation consists of five empirical studies on financial markets. Each study can be read independently and covers a specific market, either private equity, corporate bonds or emerging markets. The first study documents that risk factors cannot account for the significant excess returns of selection strategies based on value, momentum or earnings revisions indicators in the emerging equity market. The second study presents empirical evidence that security analysts do not efficiently use publicly available macroeconomic information in their earnings forecasts for emerging markets’ companies. The third study focuses on the emerging currency market and shows that a combination of macroeconomic variables and technical trading rules can be exploited to implement profitable trading strategies. Combining these two types of information improves the risk-adjusted performance. In the study on the corporate bond market we document that common risk factors do a good job in explaining the cross-section of returns on corporate bond portfolios with medium to long maturity, but significantly underestimate the returns on corporate bonds with a short maturity. Comparable evidence of a short-term corporate bond anomaly also shows up in portfolios of corporate bond mutual funds. In the last study we set out a commitment strategy that allows an investor in private equity to maintain a constant portfolio allocation to private equity given the uncertain nature of future cash flows and the limited liquidity.
... Ils trouvent que le capital-risque a sa place dans un portefeuille optimal mais que celle-ci est moindre que celle des autres actifs. 7 Baierl, Kaplan & Chen (2002) constatent une faible corrélation entre le capital-risque et les marchés financiers mais une forte volatilité des retours. 7 La composition du portefeuille optimal de Hwang et al. (2005) est discutable car elle contient des poids négatifs (positions courtes) importants, ce qui rend plus difficile l'estimation de l'apport de chaque actif. ...
Le capital-risque est une forme d'investissement soumis à une incertitude radicale. Pour y faire face, on fait appel à des intermédiaires compétents qui investissent dans les start-ups des fonds levés auprès d'investisseurs institutionnels : les capital-risqueurs. Dans cette thèse nous étudions donc le rôle de la compétence des capital-risqueurs dans l'organisation du capital-risque à l'aide de modèles théoriques et d'analyses empiriques des investissements en capital-risque réalisés aux Etats-Unis, en Europe et et Israël entre 1990 et 2005. Nous proposons tout d'abord un modèle du capital-risque basé sur une double sélection: celle des start-ups par les capital-risqueurs et celle des capital-risqueurs par les investisseurs institutionnels. Ce modèle nous permet d'établir les conditions de l'efficacité du capital-risque et d'étudier les dynamiques d'apprentissage et de sélection qui permettent de faire émerger une population de capital-risqueurs compétents à partir d'une population hétérogène aléatoire. Puis nous étudions l'influence de la compétence sur les stratégies du capital-risqueur. Nous proposons un modèle dynamique de l'arbitrage entre spécialisation industrielle et diversification financière dans le portefeuille de start-ups du capital-risqueur lorsqu'il améliore sa compétence dans les industries où il investit. Nous étudions ensuite le réseau de co-investissement entre capital-risqueurs et nous montrons le rôle des proximités culturelle, industrielle et dans le réseau comme source d'information sur la compétence des partenaires potentiels.
... This estimate is comparable to the volatility of returns for the smallest quintile of CRSP/Compustat firms during the same time period. Furthermore, this estimate is comparable to the volatility of deal-level private equity returns reported by Chen, Baierl, and Kaplan (2002), Cochrane (2005), and others. ...
... Accordingly, given the high risk of VCs financing many studies have examined the causes of such risks. Some of those studies are empirical in nature; see for example (Cochrane, 2005), (Baierl, Kaplan, et al., 2002), (Hall & Lerner, 2010) (Jain, 2001) Jain (2001), and (Kaplan & Strömberg, 2003) and (Tykvová, 2007) while others are theoretical; see (Casamatta, 2003), (Elitzur & Gavious, 2003), (Keuschnigg & Nielsen, 2003b), (Keuschnigg & Nielsen, 2003a). ...
This article aims to use a bargaining power model to reduce moral hazard—in the form of entrepreneurial effort shirking—and derive an optimum sharing ratio of a Profit and Loss Sharing (PLS) contract that involves a Venture Capitalist and an Entrepreneur. The model reveals the following interesting findings. First, under complete information—where the Venture Capitalist has a bargaining power ‐ Venture Capitalist offers the entrepreneur a profit sharing ratio that is less than her capital contribution ratio. Second, in an incomplete information setting, the entrepreneur demands a profit sharing ratio higher than her capital contribution ratio when the sum of the marginal cost (from exercising a higher effort) and private benefits (from exercising a low effort) is greater than the marginal return (from exercising a high effort). In addition, the model is used to derive a span of negotiation about the profit sharing ratio. Finally, an agent based simulation (Netlogo) platform is considered to implement the model, which allows a faster numerical calculations of the profit share and helps decide on the validity of the funding contract.
... Among studies including private equity in the strategic asset allocation of investors, Lamm and Ghaleb-Harter [13] recommend investing between 19% and 51% in private equity; their result was tested under a variety of alternative conditions and conservative assumptions about future performance. A later study of Chen et al. [14] points out the low correlation coefficient (0.04) between venture capital and stocks, suggesting an allocation of 2% (for the minimum variance portfolio) to 9% (in the maximum Sharpe ratio portfolio) for mixed asset portfolios. ...
Using a unique dataset of 50 listed companies that meet the majority of the OECD requirements for social impact investments, we construct a social impact finance stock index and investigate how investing in social impact firms can contribute to portfolio risk-return performance. We build portfolios with three different methodologies (naïve, Markowitz mean-variance optimization, GARCH-copula model), and we study the performance in terms of returns, Sharpe ratio, utility, and forecast premium based on a constant relative risk aversion function for investors with different levels of risk aversion. Consistent with the idea that social impact investment can improve portfolio risk-return performance, the results of our macro asset allocation analysis show the importance of a large fraction of investor portfolios’ stake committed to social impact investments.
... в другой работе(Schmidt, 2003) различные сценарии предполагают долю фондов от 3 до 65%. еще один взгляд на данный вопрос представлен в работе(Chen, Baierl, Kaplan, 2002), где авторы анализировали возможность вложения в венчурные фонды прямых инвестиций и пришли к выводу о том, что их доля в портфеле должна быть не более 2-9%. ...
Авторы: Илья Маркович Партин - Национальный Исследовательский Университет "Высшая школа экономики". Электронная почта: ipartin@hse.ru В процессе формирования инвестиционного портфеля индивидуальный инвестор имеет широкий набор возможностей для вложения собственных средств. В то же время, если посмотреть на возможные варианты с точки зрения вложения средств в акционерный капитал компаний, то для рядового инвестора будут доступны инвестиции только в акции публичных компаний на рынке. Возможность инвестирования в капитал частных компаний в основном может быть доступна только через приобретение долей в фондах прямых инвестиций, при этом минимальный порог для таких инвестиций довольно высок. В данной статье обсуждается возможность создания новой бизнес-модели публичной холдинговой компании, владеющей миноритарными пакетами акций множества частных компаний. Создание такого холдинга сможет предоставить как индивидуальным, так и профессиональным инвесторам новую возможность инвестиций в капитал частных компаний без участия фондов прямых инвестиций.
... МетОДы и РезулЬтАты исслеДОВАНиЙ ДОХОДНОсти ФОНДОВ ПРяМыХ иНВестиЦиЙ Гусамов С.А. 1 В эпоху глобализации углубляется взаимосвязь финансовых рынков и усиливается корреляция доходности между представленными на рынке активами. В связи с экономическим кризисом в последнее время возрос интерес к поиску новых финансовых активов, которые в меньшей степени коррелируют с традиционными инструментами, что позволяет увеличить диверсификацию и снизить волатильность портфеля. ...
Авторы:Степан Александрович Гусамов НИУ ВШЭ В эпоху глобализации углубляется взаимосвязь финансовых рынков и усиливается корреляция доходности между представленными на рынке активами. В связи с экономическим кризисом в последнее время возрос интерес к поиску новых финансовых активов, которые в меньшей степени коррелируют с традиционными инструментами, что позволяет увеличить диверсификацию и снизить волатильность портфеля. Такие финансовые активы получили название альтернативных инвестиций, и к ним, в том числе, относятся вложения в фонды прямых инвестиций (ФПИ). Данная статья представляет собой обзор исследований доходности и риска вложений в ФПИ развитых и развивающихся стран.Задача оценки доходности и риска для ФПИ не является простой ввиду специфики данного актива, которая заключается в информационной непрозрачности, нестабильности денежных потоков, низкой ликвидности и длительного периода инвестирования. Подходы к оценке доходности ФПИ постоянно совершенствуются, хотя на практике по-прежнему часто приводят к противоречивым результатам.В статье будет представлен анализ как теоретических подходов к оценке доходности и риска ФПИ, так и результаты эмпирических исследований оценки доходности и влияния на нее различных детерминантов.
... Bygrave and Timmons (1992) examined VC funds and found an average IRR based on net asset values of 13.5% for the years 1974-1989. By comparison, Chen, Baierl, and Kaplan (2002) examined 148 VC funds using Thompson Venture Economics (TVE) data-set that had been liquidated before 1999 and found an annual average return of 45% (with a standard deviation of 115%). Analysis of data from the Thomson Financial US Private Equity Performance Index found that returns to early stage VC investments over a 20-year period were 20.5% (Cumming and Johan 2010). ...
... Jain and Kini (1995) find that firms financed by venture capital experience faster growth in sales and employment. Analyses of the financial returns to venture capital investments confirm these positive aspects (Chen et al. 2002;Cochrane 2005). As proxies of the presence of financial capital in a territory, some specific variables are typically considered: venture capital availability; angel investors availability; access to debt; depth of the capital market, which is a measure of the size and liquidity of the stock market, IPO level, M&A, debt and credit market activity, and the concentration of financial services employment in the financial services sector as a percentage of total employment (Kelly and Kim 2016;Levie and Autio 2008;Prevezer 2001). ...
The paper proposes a framework for measuring and testing the causal effects of a set of entrepreneurial ecosystems factors (eco-factors) on productive entrepreneurship (eco-output). Existing research studies provide long lists of relevant eco-factors; however, the causal relations of eco-factors with productive entrepreneurship has not been sufficiently and holistically studied. As the research on entrepreneurial ecosystems continues to develop, there is a need for a measurement framework and subsequent empirical validation of these causal relations. Otherwise, research on entrepreneurial ecosystem risks engaging only in a simple description of successful territories without the possibility of generalizing findings. Therefore, our paper’s contribution is a critical review of the set of eco-factors proposed by the extant literature and propose indicators and related data sources that could be used to measure the indicators more holistically. In an analogous way, with respect to eco-output, our contribution is to trace which indicators are the appropriate proxies for productive entrepreneurship and to explore the data sources for these indicators.
... Section 4 imitates the contribution of the study, proposed hypothesis, variables, data and model. Section 5 a It is a notion that has been de¯ned as \medium term, direct equity or equity-linked investments with a well-de¯ned exit strategy in young, privately-held companies (or invests), where the investor is a¯nancial intermediary who raises and professionally manages a pool of money and is typically active as a director, an advisor, or even the manager of a¯rm [Busenitz et al. (2004); Chen et al. (2002); Cochrane (2005); Cumming (2010); Kortum and Lerner (1998); Lerner (1995)]. b It is a notion that has been de¯ned and generalized in many ways by both researchers and policy-makers, both as a process and as an outcome [Garcia and Calantone (2002); Helpman (1994, 1991); OECD (2005); Raymond and St-Pierre (2010)]. ...
The paper examines the long-run relationship between venture capital and innovation in the 19 European Economic Area (EEA) countries over the period 1989–2014. We use three different indicators of venture capital (VC), such as VC at early stage investment, VC at later stage investment, and VC total investment, and seven different indicators of innovation, such as patents-residents, patents-nonresidents, patents-total, research and development expenditure, researchers in research and development activities, high-technology exports, and scientific and technical journal articles, to examine this long-run relationship. Using cointegration technique, the study warrants the support of long-run relationship between venture capital and innovation in few cases, typically with reference to a particular VC indicator and innovation indicator. Expending the Granger causality test, the study finds the presence of both bidirectional and unidirectional causality between venture capital and innovation. However, these results vary from country-to-country within the EEA countries, depending upon the types of VC indicator and innovation indicator that we use in a particular empirical exploration process. The policy implication of this study is that the economic policies should recognize the differences in the venture capital and innovation in order to maintain the sustainable development in these EEA countries.
... Bygrave and Timmons (1992) examined VC funds and found an average IRR based on net asset values of 13.5% for the years 1974-1989. By comparison, Chen, Baierl, and Kaplan (2002) examined 148 VC funds using Thompson Venture Economics (TVE) data-set that had been liquidated before 1999 and found an annual average return of 45% (with a standard deviation of 115%). Analysis of data from the Thomson Financial US Private Equity Performance Index found that returns to early stage VC investments over a 20-year period were 20.5% (Cumming and Johan 2010). ...
Business angels are widely recognized as a significant source of entrepreneurial finance, particularly for early-stage businesses. However, rigorous investigation on angel investment performance has been limited. This paper examines investment returns of business angels in addressing the question of whether angel investing generates attractive returns. We review the few published studies which report on more than 100 investment exits to establish baseline returns expectations and clarify returns measurement limitations. We then use data from one of the largest studies of angel returns to populate a Monte Carlo simulation of returns profiles to explore the link between portfolio size and the probability of the desired level of returns. The study reveals that angel deal returns are highly skewed; smaller portfolios have higher average returns but dramatically lower median returns. In contrast with prior studies, our study shows that portfolios with more than 50 investments are required to significantly minimize risk of poor returns and that similar scale is required to maximize returns potential, as smaller portfolios have a lower average internal rate of return (IRR). We show that reinvestment rate is a critical element in measuring angel returns, and we demonstrate the limitations of IRR as a returns metric through the simulation.
... Risk capital can be classified as Private Equity (PE) or Venture Capital (VC) (GOMPERS;LERNER, 2004).In the first group (PE) we find investments of greater sum, in more mature companies and operating in well-defined markets, whereas in the second group (VC) we find investment operations in early-stage companies, with high expected returns and that are seeking to establish themselves in a market not yet fully consolidated (CFA INSTITUTE, 2009;SCHOAR, 2005;STROMBERG, 2009). The risks and expected returns on VC usually exceed those on PE (CHEN; BAIERL; KAPLAN, 2002;COCHRANE, 2005;GOMPERS;LERNER, 1997& 1999PHALIPPOU;GOTTSCHALG, 2009 5. While total investments in PE and VC in the USA amounted to 0.9% of GDP in 2012 in Brazil it remains below 0.4% of GDP. ...
ABSTRACT We consider the problem of selecting private equity funds for investment in Brazil. The proposed methodology is based on multi-criteria decision-making. Real data obtained from one of the largest pension funds in Brazil is used to illustrate a practical application of the methodology when selecting investments among eleven private equity funds available in the local financial market. The multi-criteria method TOPSIS is adopted with a total of twenty two criteria to order the investment alternatives. A sensitivity analysis is also presented. The methodology proposed allows a standardized decision-making process, facilitating the process of selecting private equity funds for investment in Brazilian financial markets.
... Although the literature off ers no ultimate conclusion on private equity returns, their correlation with other asset classes is an important property that investors and portfolio managers should consider. Private equity returns exhibit a low to negative correlation with bonds and a low correlation with equity (Chen, Baierl, and Kaplan, 2002). Th us, investors should include private equity in a portfolio to enhance the risk-return profi le if they are willing to assume some risk (Lamm and Ghaleb-Harter, 2001;Schmidt, 2004;Ennis and Sebastian, 2005). ...
The world of portfolio management has expanded greatly over the past three decades, and along with it, so have the theoretical tools necessary to appropriately service the needs of both private wealth and institutional clients. While the foundations of modern finance emerged during the 1950s and asset pricing models were developed in a portfolio context in the 1960s, portfolio management has now expanded into more complex models. Further, the traditional assumption of rational investor behavior with decisions made on the basis of statistical distributions has expanded to consider behavioral attributes of clients as well as goals-based strategies. Performance assessment has taken on greater importance since the 1990s. Portfolio management today emerges as a dynamic process that continues to evolve at a rapid pace. This 30-chapter book takes readers through the foundations of portfolio management with the contributions of financial pioneers up to the latest trends. Portfolio Theory and Management provides a comprehensive discussion of portfolio theory, empirical work, and practice. It not only attempts to blend the conceptual world of scholars with the pragmatic view of practitioners, but it also synthesizes important and relevant research studies in a succinct and clear manner including recent developments. Chapters are grouped into seven broad categories of interest: (1) portfolio theory and asset pricing, (2) the investment policy statement and fiduciary duties, (3) asset allocation and portfolio construction, (4) risk management, (5) portfolio execution, monitoring, and rebalancing, (6) evaluating and reporting portfolio performance, and (7) special topics.
... It associates the addition of hedge funds with positive effects on portfolio performance (see, e.g., Amin and Kat, 2002;Lhabitant and Learned, 2002;Amin and Kat, 2003;Gueyie and Amvella, 2006;Kooli, 2007). In addition, findings assign positive effects for private equity (see, e.g., Chen et al., 2002;Schmidt, 2004;Ennis and Sebastian, 2005). The literature also finds that real estate investment trusts (REITs) can increase portfolio performance (see, e.g., National Association of Real Estate Investment Trusts, hereafter NAREIT, 2002;Hudson-Wilson et al., 2004;Chen et al., 2005;Lee and Stevenson, 2005;Chiang and Ming-Long, 2007). ...
This chapter introduces a framework for strategic asset allocation using alternative investments along with traditional investments. The approach accounts for time series biases with alternative asset indices. A strategic asset allocation model is used that is flexible enough to capture the risk-return profile adequately, as well as incorporate real investor preferences. The results show that bonds are highly important in all portfolios, but defensive portfolios tend to use stocks of large U.S. firms. In all portfolios, emerging markets gain in relevance with decreasing risk aversion. For alternative investments, all portfolios use the maximum allocation of hedge funds and a medium allocation of commodities. Private equity is comparatively more important in defensive portfolios, whereas real estate investment trusts (REITs) gain in importance as risk aversion decreases.
... Early evidence from returns to funds of funds investment strategies (Brophy and Guthner, 1988) found that VC portfolios showed systematic risk below the S&P 500 and mutual funds and higher returns than both benchmarks, suggesting that diversification contributes to reducing firm-specific risk. Other evidence also indicates that the correlation between VC funds returns and returns on listed corporations is low (Chen et al., 2002; Diller and Kaserer, 2009), that few listed VC firms outperform the market (Manigart et al., 1994) and that the dispersion of VC fund returns is not greater than that for small stocks (Chiampou and Kallett, 1989). As might be expected, where studies have made comparisons, the betas on leveraged buyout (LBO) funds are lower than for VC funds (Jones and Rhodes-Knopf, 2004). ...
The Investment appraisal and valuation process of venture capitalists includes Information gathering, the assessment of risk and required return, and the choice of a valuation method. This process is empirically studied in the United Kingdom, the Netherlands, Belgium, and France. The Importance of different information sources is equal in the four countries, except that the French venture capitalists Place more emphasis on personal references and the track record of the entrepreneur. The required return is lowest in the Netherlands and Belgium for every development stage of a company, and highest in the UK. The most widely used valuation method in the UK is the multiplication of past or future earnings with some price-earnings ratio. In the Netherlands and Belgium it is the discounting of future cash flows, and in France it is the book value of the net worth.
... They find that that PE allocations should be around 19-51 per cent, depending on mean return targets. Chen et al (2002) take VC data (periods 1968-1999) also from Venture Economics. They model returns using stock market returns and a multinormal distribution for specific VC investments returns. ...
Long-term investments such as Private Equity (PE), present timing differences in cash inflows and outflows. When allocations in PE are not planned correctly, investors can suffer liquidity problems when paying for unexpected commitments. We present a multistage stochastic optimization model that includes PE assets as free cash flows projects. This model can determine PE allocations, in relation to public equity, under different market settings. Using a factor-based model to construct public and private equity markets, the major findings are: Liquidity problems can be avoided by planning PE allocations in advance and according to market conditions. Our tool reduces commitments taken for more volatile PE market or when investor target is lower. For target returns above 20 per cent, PE allocations enhance portfolio annual returns from 2 to 3 per cent (no volatility increase) only if PE net present value volatility is below 15 per cent. Beyond this point, higher returns comes with more risk. When PE investments are less correlated with public equity, the latter threshold extends to 45 per cent. PE allocation weight changes in time and according to its age. For favorable market conditions and high investors' appetite, PE investment value can be greater than the entire wealth at some time periods. Leverage option for PE investments decreases performance, even in low PE volatility market. Potential PE gains are offset by debt interest payments and risk becomes higher.
... Early evidence from returns to funds of funds investment strategies (Brophy and Guthner, 1988) found that VC portfolios showed systematic risk below the S&P 500 and mutual funds and higher returns than both benchmarks, suggesting that diversification contributes to reducing firm-specific risk. Other evidence also indicates that the correlation between VC funds returns and returns on listed corporations is low (Chen et al., 2002;Diller and Kaserer, 2009), that few listed VC firms outperform the market and that the dispersion of VC fund returns is not greater than that for small stocks (Chiampou and Kallett, 1989). As might be expected, where studies have made comparisons, the betas on leveraged buyout (LBO) funds are lower than for VC funds (Jones and Rhodes-Knopf, 2004). ...
The principal goal of this monograph is to provide an overview of relevant aspects and research findings pertaining to the period after the venture capital firm (also known as venture capitalist or VC) has made the decision to invest in a particular portfolio company (or entrepreneur). Drawing principally upon refereed journal papers in entrepreneurship, finance, and management, our review is divided into six principal areas: (1) what venture capital firms do, (2) the impact of VCs on portfolio firms and other stakeholders, (3) the role of syndication, (4) the nature and timing of exit from VC investment, (5) the role of VCs in portfolio companies that undergo an initial public offering (IPO), and (6) the returns from investing in VC. The monograph concludes with a detailed outline of an agenda for further research. We provide a summary of the main papers in this literature in a set of tables in which we identify the authors, publication date, the journal, the main research question, the theoretical perspective, data, and the principal findings.
... We therefore do not follow the method proposed by Rouvinez. Another method is that proposed by Chen et al. (2002). They assume that cash flows are reinvested at the IRR. ...
... The paper is related to the scarce literature on portfolio optimization involving private equity funds. The only papers that also address this issue are Chen et al. (2002), Cumming et al. (2010), and the contemporaneous work of . However, these papers ignore many important aspects of the asset class, such as illiquidity of private equity fund investments. ...
This paper extends the standard Merton portfolio choice model to include illiquid private equity funds. This is done in a realistic modeling framework where private equity funds cannot be traded during their entire bounded lifecycle and involve capital commitments and intermediate capital distributions that cannot be reinvested immediately. Assuming an investor that derives CRRA power utility from terminal portfolio wealth, the paper solves for a dynamic commitment and portfolio strategy that shows investors how to optimally commit capital to private equity funds and how to optimally rebalance between liquid stocks and bonds over time. The framework also allows directly studying the effects of illiquidity on optimal portfolio allocations and on investors' utilities. These results provide a number of important insights about the effects of illiquidity of private equity funds. Most importantly, the paper shows that liquidity associated welfare losses are negligible in case that private equity funds and traded stocks are relatively close substitutes, i.e. both have similar risk-return characteristics and a medium or high return correlation. This finding sheds new light on the discussion why many recent papers document that private equity funds only generate returns that are comparable to traded stocks despite being highly illiquid investments.
... Naast het verkrijgen van een liquiditeitspremie biedt private equity de mogelijkheden de beleggingsportefeuille te diversifi ëren en een beter risico/rendementprofi el te verkrijgen. De rol van private equity in een gediversifi eerde portefeuille is onderzocht door Chen et al. (2002) en Schmidt (2004). Zij claimen dat 10 tot 15 procent van een portefeuille aan private equity toegewezen dient te worden. ...
In de laatste decennia heeft private equity zich
ontwikkeld tot een belangrijke component van ondernemingsfi
nanciering. Private equity is een bron van fi nanciering voor
start-up ondernemingen, private middelgrote ondernemingen,
ondernemingen die geherstructureerd worden of onder nemingen
die hun beursnotering willen beëindigen. De ontwikkelingsgang
van private equity kent een golfpatroon dat gekenmerkt wordt
door perioden van expansie en perioden van verschansing. Dit
artikel beschrijft aan de hand van de recente literatuur de privateequitygolf,
en de consequenties voor de verschillende partijen
in de markt voor private equity, zoals de ondernemingen die
privaat gefi nancierd worden, de investeringsmaatschappijen en
de verschaffers van privaat vermogen.
... After adjusting his results for the survivorship bias, the author calculates mean average returns to be equal to 59% with a standard deviation of 107%. Chen, Baierl, and Kaplan (2002) examine 148 venture capital funds in the TVE data set that have been liquidated before 1999. By assuming intermediate cash flows to be reinvested at the IRR they find an annual average return of 45% with a 5 A short definition of this methods is given in section 4. 5 standard deviation of 115%. ...
This paper analyzes the determinants of returns generated by European private equity funds. It starts from the presumption that this asset class is characterized by illiquidity, stickiness and segmentation. As a consequence, Gompers and Lerner (2000) have shown that venture deal valuations are driven by overall fund inflows into the industry giving way to the so called 'money chasing deals' phenomenon. It is the aim of this paper to document that this phenomenon also explains a significant part of variation in private equity funds' returns. This is especially true for venture funds, as they are more affected by illiquidity and segmentation than buy-out funds. Actually, the paper presents a WLS-regression model that is able to explain up to 47% of variation in funds' returns. Apart from the importance of fund flows we can also show that market sentiment, the GPs' skills as well as the idiosyncratic risk of a fund have a significant impact on its returns. Moreover, they seem to be unrelated to stock market returns and negatively correlated with the development of the economy as a whole. According to a bootstrapping inference the results seem to be quite stable. --
... The impact of our paper to the existing literature is twofold. First, we present a new approach to measure the return of a private equity fund based on a stochastic 1 See Chen et al. (2002) for references. 2 The phenomenon of stale pricing in illiquid asset markets is extensively discussed in Getmanski et al. (2003) and Kaserer et al. (2003). For managed pricing in the private equity industry see Anson (2002). ...
In this paper, we present a new approach to measure the returns of private equity investments based on a stochastic model of the dynamics of a private equity fund. Our stochastic model of a private equity fund consists of two independent stages: the stochastic model of the capital drawdowns and the stochastic model of the capital distributions over a fund's lifetime. Capital distributions are assumed to follow lognormal distributions in our approach. A mean-reverting square-root process is applied to model the rate at which capital is drawn over time. Applying equilibrium intertemporal asset pricing consideration, we are able to derive closed-form solutions for the market value and time-weighted model returns of a private equity fund. --
... It associates the addition of hedge funds with positive effects on portfolio performance (see, e.g., Amin and Kat, 2002;Lhabitant and Learned, 2002;Amin and Kat, 2003;Gueyie and Amvella, 2006;Kooli, 2007). In addition, findings assign positive effects for private equity (see, e.g., Chen et al., 2002;Schmidt, 2004;Ennis and Sebastian, 2005). The literature also finds that real estate investment trusts (REITs) can increase portfolio performance (see, e.g., National Association of Real Estate Investment Trusts, hereafter NAREIT, 2002;Hudson-Wilson et al., 2004;Chen et al., 2005;Lee and Stevenson, 2005;Chiang and Ming-Long, 2007). ...
We introduce a framework for strategic asset allocation with alternative investments. Our framework uses a quantifiable risk preference parameter, λ, instead of a utility function. We account for higher moments of the return distributions and approximate best-fit distributions. Thus, we replace the empirical return distributions with two normal distributions. We then use these in the strategic asset allocation. Our framework yields better results than Markowitz’s framework. Furthermore, our framework better manages regime switches that occur during crises. To test the robustness of our results, we use a battery of robustness checks and find stable results.
... In their study this recommendation is appropriate under a variety of alternative conditions and conservative assumptions regarding future performance. A later study by Chen, Baierl and Kaplan (2002) point out the a low correlation coefficient of 0.04 between venture capital and public stocks. Because of its relatively low correlation with stocks, an allocation to venture capital of 2% (for the minimum variance portfolio) to 9% (in the maximum Sharpe ratio portfolio) is warranted for mixed asset portfolios. ...
Most monthly return distributions of alternative as sets are in general not normally distributed. Further, some have biases (e.g. survivor ship bias) that distort the risk-return profile. For that reason every portfolio optimization in the mean-var iance framework which includes alternative assets with not normally distributed re turn distributions and/or biases will most likely be sub-optimal since the risk-return is not covered adequately. As a result the biases and higher moments have to be taken into account. For that reason the return series are corrected for biases in a first step. In the next s tep the empirical return distributions are replaced with two normal distributions to approxima te a best-fit distribution to cover the impact of the higher moments. This procedure is kno wn as the mixture of normal method and is widely used in financial applications. In order to build a strategic asset allocation for a mixed asset portfolio traditional investments (stoc ks and bonds) and the vast majority of alternative investments (asset backed securities, h edge funds, venture capital, private equity (buy out), commodities, and REITs) are considered. Furthermore real investor's preferences are considered in optimization procedure. In order to test the results for stability robustness tests which allow for the time-varying correlation structures of the strategies are applied.
... This is slightly higher than the standard deviation across all rounds of funding which is 107%. Peng Chen, Gary Baierl and Paul Kaplan[7] find a slightly higher standard deviation over all rounds of finance of 116%.VC's equity share: Kaplan and Stromberg[18] have a data set with 213 investments by 14 venture capital firms. The data include the contractual agreements governing each financing round in which the firm participated. ...
We develop a model of informed finance that explains the key qu alitative and quantitative features of informed venture capital finance in the United States. We sho w that the two key features of our model— potential investors are better judges than entrepreneurs o f a project's economic viability and projects require both significant external funding and entrepreneur ial inputs—give rise to under-financing with equity and over-financing with debt. We then take the model to the data. Using only four model param- eters we match: (1) the venture capitalist's equity share; ( 2) the venture capitalist's expected return and (3) its standard deviation; (4) the probability that a proje ct receives funding; and (5) the probability the venture capitalist loses money on an investment. Our estimated parameters reveal the average quality of an unfunded project; the percentage of uncertainty resolved by the venture capitalists investigation; the percentage of total surplus accruing to the venture capi talist, and the magnitude of underfinancing associated with venture capital finance.
Venture capital (VC) is a key catalyst for nurturing start-up firms with high-growth potential to undertake innovative endeavors that contribute to national wealth. Existing literature concentrates on the impact of venture capital on firm-level performance. Unlike much of the earlier work, we conduct a macro study examining short-term and long-term relationships between VC investment, the state of the financial sector, and economic growth in 20 European single market countries between 1989 and 2015. We show that major transformations (political, economic, financial and institutional) over the sample period in the Eurozone region have resulted in the data series used in the study (economic growth, financial sector development, and VC investment) to be non-stationary. As such, the vector error-correction model (VECM) and Granger-Causality test are used to examine short-term and long-term relationships between VC investment, financial development, and economic growth for the sample countries. The findings suggest that economic growth strategies and financial sector reforms are critical for a vibrant venture capital industry. In the short term, there are bi-directional relationships between some of the variables. These results suggest that plans to create a vibrant venture capital industry will reinforce financial sector development and economic development, creating a more sustainable economic development model for countries in the Eurozone region.
This paper examines the long-run relationship between venture capital investment and per capita economic growth in the 19 European Economic Area (EEA) countries for the period 1989-2014. We use three different indicators of venture capital (VC) investment, namely VC at early stage investment, VC at later stage investment, and VC total investment. Using cointegration technique, the study warrants the support of long-run relationship between VC investment and per capita economic growth in a few cases, typically with reference to a particular VC indicator and per capita economic growth we use. Using vector auto-regressive (VAR) model for testing the Granger causalities, the study acknowledges mixed evidence of the relationship between the venture capital investment and per capita economic growth in the selected EEA countries, both by individual country and at the panel setting. In some instances, venture capital investment leads to per capita economic growth, lending support to supply-leading hypothesis (SLH) of VC investment-growth nexus. In other instances, it is the per capita economic growth that regulates the level of venture capital investment, lending support to demand-following hypothesis (DFH) of VC investment-growth nexus. There are also circumstances, where venture capital investment and per capita economic growth are mutually interdependent. That is the situation where both are self-reinforcing and offer support to feedback hypothesis (FBH) of VC investment-growth nexus. In addition, there are also instances, where the venture capital investment and per capita economic growth are independent of each other. This is the situation where both are neutral and offer support to neutrality hypothesis (NLH) of VC investment-growth nexus. To summarize, Granger causality results vary from country to country within the EEA countries, depending upon the type of venture capital investment and per capita economic growth that we use in a particular empirical exploration process. The policy implication of this study is that the economic policies should recognize the differences in the venture capital investment and per capita economic growth in order to maintain sustainable development in these EEA countries.
IntroductionHistoryThe Structure of Private Equity FundsPrivate Equity InvestmentInternationalization of Private EquityPrivate Equity PerformanceConclusion
NotesAbout the Author
Alternative investments are defined as asset classes that fall outside of traditional investments, such as stocks, bonds, and cash. Real estate, private equity, commodities, managed futures, hedge funds, and distressed securities are all examples of alternative investments. Although the characteristics of each of these assets differ from the others, all tend to share the ability to offer diversification for a traditional portfolio through enhanced returns, reduced risk, and/or improved risk-adjusted performance. Yet, because of relative illiquidity, complexity, or minimum investment requirements, alternatives are often unsuitable or are beyond the reach of some investors. This chapter offers an overview to alternative investments and to the remaining 27 chapters. These chapters provide theoretical and empirical evidence about the usefulness of these assets in the portfolio management process.
The term private equity typically includes investments in venture capital or growth investment, as well as late stage, mezzanine, turnaround (distressed), and buyout investments. It typically refers to the asset class of equity securities in companies that are not publicly traded on a stock exchange. However, private equity funds do in fact make investments in publicly held companies, and some private equity funds are even publicly listed. Articles in this volume cover both private and public company investments, as well as private and publicly listed private equity funds. This publication provides a comprehensive picture of the issues surrounding the structure, governance, and performance of private equity. It comprises contributions from forty-one authors based in fourteen different countries, and is organized into seven parts, the first of which covers the topics pertaining to the structure of private equity funds. Part II deals with the performance and governance of leveraged buyouts. Part III analyzes club deals in private equity, otherwise referred to as syndicated investments with multiple investors per investees. Part IV provides analyses of the real effects of private equity. Part V considers the financial effects of private equity. Part VI provides analyzes of listed private equity. Finally, Part VII provides international perspectives on private equity.
Private equity has become an important asset class for institutional investors. As the asset class grows and investors get more experienced, the debate concerning transparency and governance of private equity funds has intensified. Fund investors demand more disclosure from private equity fund managers. Are these calls justified? What information do fund investors need? How can private equity fund investors manage their exposure to the asset class effectively? Kay Müller presents an in-depth analysis into the monitoring activities of institutional investors and explores their information requirements by interviewing leading European private equity fund investors. He contrasts these results with the actual reporting by fund managers and reveals essential information gaps based on a disclosure study of private equity fund reports. Since effective and open communication supports long-lasting and trusted partnerships, these findings provide important guidance on how to improve the relationships between investors and fund managers in the private equity industry. © Betriebswirtschaftlicher Verlag Dr. Th. Gabler GWV Fachverlage GmbH, Wiesbaden 2008. All rights reserved.
This chapter examines abnormal performance and systematic risk of private equity investments around the world. The methodology extends the standard internal rate of return (IRR) approach and allows the estimation of systematic risk and abnormal returns of a cross-section of private equity investment cash flows. The empirical results show that the systematic risk (beta) for the venture and buyout investments is significantly different from 1.0, while abnormal returns (as measured by alpha) are significantly positive for both types of deals. Buyout investments are characterized by lower systematic risk and higher abnormal performance than venture capital investments.
This paper examines the risks and returns of venture capital investments using the Fama–French (Journal of Financial Economics, 1993; 33: 3) factor model and cash flow data. In doing so, this paper extends the single-stage generalized method of moments (GMM) estimation approach proposed by Driessen et al. (Journal of Financial and Quantitative Analysis, 2012; 47: 511) to iterative GMM estimation by explicitly introducing the heteroskedasticity consistent covariance estimator. The iterative GMM method is simpler and faster to implement, it allows for a formal test for over-identifying restrictions, and it seems to perform well in the small sample herein. Using the venture capital cash flow data of all liquidated funds incepted from 1999 to 2006 compiled by the Korea Venture Capital Association (KVCA), this paper finds that both market and high-minus-low (HML) factors are important. Unlike experiences in the United States market, however, the contribution of market factors is small and positive, whereas the contribution of HML factors is large and negative in the emerging market in Korea. This means that Korean venture capital strategies take a short position in value stocks and a long position in growth stocks. Because growth stocks lag while value stocks perform well during the sample period herein, the cost of capital turns out to be nearly zero. This is compensated for by a large positive abnormal return, yielding the expected return of 11.05% per year on venture capital investments in the Korean market.
Venture capital (VC) cross-border syndication has increased significantly in recent years. This study examines the risk and returns of investments of US–European cross-border syndicates in US portfolio companies. We use a large sample of investments across four financing stages, and highlight several noteworthy differences between cross-border syndicates and previous US-only evidence. By comparison, US–European syndicates are larger than US-only syndicates, involve younger VCs, and focus more on later financing stages. Controlling for sample selection bias caused by the endogenous choices of exit route and exit timing, we examine the risk and returns of investments backed by cross-border syndicates. Consistent with evidence from US-only syndicates, alpha and beta decrease monotonically from the earliest (start-up) stage to the later stages of financing.
This article reviews the authors' discussion on private equity funds from their book "Exposed to the J-curve: Understanding and Managing Private Equity Fund Investments" (published by Euromoney Investors Plc). The reader will learn about the most important issues in dealing with private equity fund investments from the perspective of the limited partner, and benefit from free access to an extensive bibliography on private equity funds for further reading. Private equity funds include funds investing into venture capital, late stage investments such as management buyouts and special situation financing.
Real-Estate-Private-Equity (REPE)-Finanzierungen haben sich in den Vereinigten Staaten beginnend Ende der achtziger Jahre bis Ende der neunziger Jahre zu einer bedeutenden Finanzierungsform für Immobilienprojekte entwickelt. Investoren haben jüngst auch im deutschen Immobilienmarkt großvolumige Private-Equity-Transaktionen durchgeführt. Gleichzeitig entdecken institutionelle Anleger zunehmend Private Equity als Anlagealternative. Der vorliegende Beitrag stellt das Konzept von REPE-Fonds im Überblick dar und diskutiert, inwiefern diese als eigenständige Anlageklasse für institutionelle Anleger betrachtet werden können. --
One of the greatest problems institutional investors face in evaluating alternative investments such as venture capital, real estate, and hedge funds is determining the normal or policy allocation. The typical approach relies on single-period optimization programs, using historical data as key inputs. This is subject to problems such as enormous allocations to private equity and other non-market-priced investments. Instead, the authors use a factor approach to build a consistent set of return and risk characteristics for conventional and alternative asset classes alike. Simulation techniques rather than optimization provide better insight into the characteristics of the portfolio over time as market swings and liquidity constraints force divergence from the desired policy mix.
Taking into account that research on organizational trust is fragmented, the present article proposes an integrated view of the episode of trust in organizations. To this end, the authors define trust and analyze its proximal and distal sources. They also examine the potential role of context, again considering proximal and distal facets. In addition, they explore the consequences of organizational trust leading to private and public social capital. Finally, the authors consider different levels of construct in the analysis of the trust episode in organizations. This effort helps integrate dispersed research efforts and reveals neglected research areas in the investigation on organizational trust and its connections to social capital.
In this article the risk and return characteristics and diversification benefits when private equity is used as a portfolio component are investigated. The analysis is based on actual cash flows to and from portfolio companies. Using a dataset that provides complete information for 3620 investments made by 123 funds from 37 investment managers the authors find a dramatic increase in the extent to which private equity outperforms stock investment during the late 1990s. Within the overall class of private equity, returns on earlier private equity investment categories, including venture capital, show on average higher variations and even higher rates of failure. However, by selecting a few extremely well-performing companies, one can achieve high average returns, thus compensating for lost investments. An analysis of various private equity subcategories shows that there is a wide range of optimal allocations to this asset class that minimizes mixed-asset portfolio variance or maximizes performance ratios.
This study analyzes the performance of investments made by venture-capital (VC) funds that specialize in financing minority business enterprises (MBEs). Existing studies document that MBEs have less access to financing—equity as well as debt—than similarly situated firms owned by nonminority whites. The apparent existence of a discriminatory financing environment creates an underserved market and, hence, attractive opportunities are available to firms capable of identifying and serving MBE financing needs. Analyzing cash-flow data on VC investments, we find that the minority-oriented funds earned yields on their realized equity investments that were slightly higher than the returns reported by mainstream VC funds. Considering differences in methodologies used to generate rate-of-return data for the MBE—as opposed to the nonminority-oriented funds—we conclude that the minority VC funds are earning yields on their realized investments that are at least equivalent to those of the broader VC industry.
This paper examines the suitability of private equity as an investment for pension funds. We describe the main characteristics of private equity, examine the historical investment performance of independent private equity managers in South Africa, and discuss the importance of private equity in the asset allocation decision. We suggest that underlying private equity assets do not constitute a separate asset class. However, private equity funds, the main vehicles through which pension funds and other institutional investors may access private equity assets have unique characteristics – a specific style of active management, particular fee structures, a long investment horizon and limited liquidity, and may therefore be considered a separate asset class. Although some of these characteristics may represent drawbacks, these drawbacks are mitigated by high investment returns and diversification benefits. We investigate the investment performance of a sample set of 11 South African private equity funds over a 13-year period and find a performance premium of 18% p.a. relative to listed South African equities and a low correlation to the performance of conventional asset classes. We further find that returns after fees decrease by an average of 6% p.a., with the impact of costs increasing with fund performance. We also examine private equity in the context of pension fund asset allocation. We perform a mean-variance analysis and find that an allocation of up to 10% of assets improves the efficiency of a portfolio and contributes to meeting real return investment objectives. We further review the impact of private equity on social development and find that private equity contributes strongly to Black Economic Empowerment. We suggest that long-term savings vehicles such as pension funds are uniquely positioned to manage the long investment term and limited liquidity of private equity investment to capture what appears to be a significant performance premium and diversification benefits.
This paper presents a cash flow based analysis of the return and risk characteristics of European Private Equity Funds. For that purpose a comprehensive data set has been provided by Thomson Venture Economics. We document the typical time pattern of cash flows for European private equity funds. Specifically, it is recorded that the average European private equity fund draws down 23% of total committed capital on the vintage date; within the first three years 60% of the total commitment is draw down. It turned out that limited partners on average get back the money invested slightly after 7 years. Over the time period from 1980 to June 2003, we calculate various performance measures. For that purpose we use only liquidated funds or funds with a small residual net asset value. Under this restriction one specific data set consists of 200 funds. We document a cash flow based IRR of 12.7% and an average excess-IRR of 4.5% relative to the MSCI Europe equity index. In order to circumvent the problems associated with the IRR-approach we focus on the alternative public market equivalent approach. There it is assumed that cash flows generated by a private equity fund are reinvested in a public market benchmark index. We record an average PME of 0.96 and a value-weighted average PME of 1.04. Based on the PME-approach we develop a viable methodology to estimate the return and risk characteristics of European private equity funds and the correlation structure to public markets. As a benchmark index we used the MSCI Europe Equity Index as well as the J.P. Morgan Government Bond Index. Over the period 1980-2003 private equity funds generated an overperformance with respect to the bond index and two of our three samples an underperformance with respect to the equity index. Over the period 1989-2003 private equity funds generated an overperformance with respect to both indexes. Finally, we analyze to what extent performance measures are associated with specific funds characteristics, like size, payback period and vintage year, respectively. While the payback period and the vintage year seem to have a statistically significant influence on a fund's performance, the results with respect to size are inconclusive.
A number of academic papers have indicated that returns for private equity funds, on average, have not outperformed public equities in the United States. This contradicts the risk premium one might expect with private equity, given the liquidity, transparency limitations, and additional origination costs associated with private equity investments. In this paper, Brandes Institute Advisory Board member Bruce Grantier examines the academic research and historical performance (both on an asset class and manager value-added basis) to evaluate small cap as an alternative investment to private equity.
Venture capital limited partnerships are an attractive arena to study cross-sectional and time-series variations in compensation schemes. We empirically examine 419 partnerships. The compensation of new and smaller funds displays considerably less sensitivity to performance and less variation than that of other funds. The fixed base component of compensation is higher for younger and smaller firms. We observe no relation between incentive compensation and performance. Our evidence is consistent with a learning model, in which the pay of new venture capitalists is less sensitive to performance because reputational concerns induce them to work hard.
Venture capital distributions, a legal form of insider trading, provides an ideal arena for examining the share price impact of transactions by informed parties. These sales, which occur after substantial run-ups in share value, generate a substantial price reaction immediately around the event. In the months after distribution, returns apparently continue to be negative. When the short- and long-run reactions are decomposed, they are consistent with the view that venture capitalists use inside information to time stock distributions: Distributions of firms brought public by lower quality underwriters and of less seasoned firms have more negative price reactions. Copyright The American Finance Association 1998.
London Graduate School of Business Studies, and University of North Carolina, Chapel Hill, respectively. This work was partially supported by the National Science Foundation, Grant Number RDA 75–22652