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Private Equity-, Stock- and Mixed-Asset Portfolios: A Bootstrap Approach to Determine Performance Characteristics, Diversification Benefits and Optimal Portfolio Allocations
Abstract
In this article, we investigate risk return characteristics and diversification benefits when private equity is used as a portfolio component. We use a unique dataset describing 642 US-American portfolio companies with 3620 private equity investments. Information about precisely dated cash flows at the company level enables for the first time a cash flow equivalent and simultaneous investment simulation in stocks, as well as the construction of stock portfolios for benchmarking purposes. With respect to the methodology involved, we construct private equity, stock-benchmark and mixed-asset portfolios using bootstrap simulations. For the late 1990s we find a dramatic increase in the extent to which private equity outperforms stock investment. In earlier years private equity was underperforming its stock benchmarks. Within the overall class of private equity, returns on earlier private equity investment categories, like venture capital, show on average higher variations and even higher rates of failure. It is in this category in particular that high average portfolio returns are generated solely by the ability to select a few extremely well performing companies, thus compensating for lost investments. There is a high marginal diversifiable risk reduction of about 80% when the portfolio size is increased to include 15 investments. When the portfolio size is increased from 15 to 200 there are few marginal risk diversification effects on the one hand, but a large increase in managing expenditure on the other, so that an actual average portfolio size between 20 and 28 investments seems to be well balanced. We provide empirical evidence that the non-diversifiable risk that a constrained investor, who is exclusively investing in private equity, has to hold exceeds that of constrained stock investors and also the market risk. From the viewpoint of unconstrained investors with complete investment freedom, risk can be optimally reduced by constructing mixed asset portfolios. According to the various private equity subcategories analyzed, there are big differences in optimal allocations to this asset class for minimizing mixed-asset portfolio variance or maximizing performance ratios. We observe optimal portfolio weightings to be between 3% and 65%.
... In the literature studies which attempt to quantify the risk-return characteristics of private equity are rare. The rationale behind this is the low transparency of private equity markets and the resulting insufficient available data which hinders a comparison to other asset classes on an aggregate level [Schmidt (2004)]. Further, the target companies of the private equity funds are in general not traded in a permanent market place with quoted prices. ...
... 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. Schmidt (2004) recommends a wide range of optimal portfolio weightings to be between 3% and 65% for minimizing mixed-asset portfolio variance or maximizing performance ratios. The latest study conducted by Ennis and Sebastian (2005) implicates differentiating portfolio allocations for different types of investors. ...
... 14 The papers of Cumming, Schmidt and Walz (2004), , Schmidt (2004) and Schmidt, Steffen and Szabo (2007) give detailed insights about the index construction and its composition. series' will eventually adjust to equilibrium. ...
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.
... Jones and Rhodes-Kropf explicitly assess the risk premium inherent in private equity investments. Some recent studies, such as Schmidt (2003) and Gottschalg et al. (2004) question the positive alpha returns of private equity investment. In this paper we investigate whether PE investments generate a return premium over public stock markets on the project level gross of all externalities. ...
... The dataset used in this study is closely related to the one used by Schmidt (2003) and Cummings et al. (2004). Compared to these studies the dataset has grown since then. ...
... The discount rate is equal to the return of the benchmark investment. For investment i the PME is defined as: Schmidt (2003), pp. 11 22 Kaserer / Diller (2004) define PME as the "…ratio of the terminal wealth obtained under the (public market) reinvestment hypothesis when investing in a private equity fund compared to the terminal wealth obtained when investing the same amount of money in the given public market index." ...
In this paper we investigate the risk return relationship of Private Equity (PE) relative to Public Market Equity (PM) investments to assess the adequateness of PE's return premium. We analyze cash flows of PE projects gross of fees and any other externalities. Our analysis is based on simulated PM investments, mimicking the cash flow patterns of the PE investments. The comparison of alternative cash flow based performance measures reveals a substantial impact of the reinvestment hypothesis. Prior to any risk adjustment, PE investments outperform their PM counterparts with varying levels depending on the chosen benchmark (broad, industry specific, local). Next we compare standard risk measures and find downside deviation and shortfall to better describe the characteristics of not normally distributed PE investment returns than standard deviation. Thus, it is not surprising to observe substantially higher Sharpe Ratios for PM relative to PE investments. We adjust the Sharpe Ratio measuring risk in terms of downside deviation and still observe underperformance of PE relative to PM investments, with very heterogeneous results regarding industry, stage and size of the investments. Last we introduce Omega as alternative risk adjusted performance measure, because its risk definition better suits the characteristics of PE investments. For our PE sample we observe adequate excess returns over public stock markets given the higher shortfall risk. Our findings question the existence of an illiquidity puzzle on the fund level. Overall PE returns are highly skewed and very heterogeneous. We find later stage to be more attractive than early stage investments due to higher risk adjusted returns. As the PE investment universe is on average of poor quality compared to public equity markets, investment selection ability is of crucial importance.
... некоторым авторам удается получить детальные данные по денежным потокам фондов, чтобы на их основе провести сравнение доходности фондов и акций публичных компаний. так, в работе шмидта (Schmidt, 2003) проводится анализ 642 законченных инвестиционных проектов фондов в сша за период с 1970 по 2022 год. данные инвестиции включают в себя не только успешные случаи, но и такие, когда приобретенные компании остались частными или когда инвестиции были списаны из-за убытков. ...
... ). так, в работе (McFall, Ghaleb-Harter, 2001) рассчитывается, что оптимальная доля инвестиций в фонды в портфеле должна быть между 19 и 51%. 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.
... 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). Th e costs of a private equity investment, however, should not be underestimated. ...
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.
... • the number of portfolio companies per investment manager and performance exhibit an inverted U-shaped curve (Jääskeläinen et al., 2002;Schmidt, 2004), ...
... Results also show that EREITs return respond positively to stock returns in various states and conditions. Schmidt (2004) investigates risk return characteristics and diversification benefits when private equity is used as a portfolio component. Schmidt finds that private equity outperforms stock investment. ...
Using recent data (2002-2012) from the US financial markets, we study the magnitude and benefits of Real Estate Investment Trust (REIT) and common stock in portfolio diversification. In particular, we examine the effects of risk-reduction benefits through diversifying among common stocks via Equity REITs (EREITs) and Mortgage REITs (MREITs). In addition, overall performance measures are calculated and compared among REIT, common stock and mixed-asset portfolios. We observe that investors can benefit from diversification using EREITs but not MREITs. In fact, MREITs turn out to be the worst asset class to be in diversifying portfolio. This conclusion is in contrast with Kuhle (1987) who claims improvement of portfolio risk reduction with MREITs. Our finding, however, is consistent with Hartzell et al. (1986) and Chen et al. (2005). Finally, even though our data period consists one of the historic collapses of real estate market in the US, it still indicates the EREITs still offers diversification benefits. It provides evidence that small investors can use EREITs to diversify their risks. It also offers an opportunity to earn return on real estate investments without investing in real estate properties which may be beyond investor's capacity.
... 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. Gompers and Lerner (1997), Schmidt (2003) and, in particular, Ljungqvist and Richardson (2003) and attempt to overcome these problems by undertaking a more detailed level of analysis in which the individual investments of a fund are considered (see Section I for a detailed survey of the literature). ...
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.
... Several authors analysed private equity investments in an institutional portfolio (Koren & Szeidl (2002), Zimmermann et al. (2005), Schneeweis, Karavas, Georgiev (2002) and Schmidt (2004)). In their articles they try to assign portfolio allocation weights to private equity and analyse the risks and return characteristics of the entire portfolio (in different market conditions). ...
... 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.
... 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.
... The data is derived from detailed due diligence and (partially) audited monitoring information of PE and VC Funds collected by the Center of PE Research (CEPRES), Germany. A more detailed introduction of the CEPRES database is provided in the empirical studies of , Cumming, Schmidt and Walz (2004) and Schmidt (2004). ...
The stepwise allocation of capital from an investor to a company is described as staging. The importance of staging as a mechanism to control an investment and to affect its success has been confirmed uniformly by several authors. But the findings on the direction of the influence of staging on investment performance have created a not yet solved puzzle. To measure this influence precisely we create a unique dataset by merging the Venture Economics and CEPRES * databases. We analyze 712 matched Private Equity and Venture Capital investments including 1.549 financing rounds and 2.329 precisely dated cash injections. We take a new approach by segmenting the post-investment period in three phases of equal lengths and analyzing the influence of staging on the overall investment performance for each of these investment phases. Our findings shed light on the bright and dark side of staging. Our results show that during the initial investment phase, the investor uses staging foremost as monitoring instrument to mitigate agency problems and to provide added-value resources to the company resulting in significant positive influence on the investment performance. Staging has little impact on performance during the maturity phase. However, during the pre-exit phase we find evidence that investment managers face a termination dilemma and do not rigorously use staging as an option to terminate unsuccessful investments in time. They rather use staging for the attempt to turn around critical situations and partially for window dressing purposes. By this staging behaviour they throw good money after bad.
... CEPRES requests the data directly from the cooperating fund managers through standardized information request sheets and additionally validates the data with due diligence reports, including audited filings to guarantee high quality information. The empirical studies of Cumming and Walz (2004), Cumming et al. (2004) and Schmidt (2004) also provide more detailed information about the CEPRES database. ...
This study examines the investor's decision on the exit of loss making projects. The investor faces a liquidation dilemma: follow-on financing versus terminating a loss making investment, and thereby giving up the turn-around option. I examine the role of investment experience on solving this liquidation dilemma. Evidence from a sample of 712 realized Private Equity and Venture Capital investments confirms that young and inexperienced fund managers (i) hold loss-making investments longer, (ii) invest a higher share of the fund's portfolio capital into these losers, and (iii) provide relatively more financing rounds to these deals before the exit compared to more experienced funds. The results are robust to controlling for potential reputational concerns.
... Contrary to this idea, Gompers and Lerner (1999) argue that reputational concerns induce younger partnerships to work hard to achieve success. A further explanation for a possible negative influence is provided by Schmidt and Wahrenburg (2004). They argue that managers of established funds are older and closer to retirement and therefore put less weight on the effects of their actions on future business opportunities. ...
Previous papers that examined investment decisions by private equity funds are divided on whether staging has a positive or negative effect on returns. We believe these opposing views can be reconciled by studying when staging is used during the life of the investment relationship: We find that staging has a positive effect on investment returns in the beginning of the investment relationship, consistent with the notion that staging helps mitigate information asymmetry. However, staging appears to be negatively associated with returns when used prior to the exit decision. Our unique dataset allows us to measure these intertemporal effects precisely.
... Much less is known on the impact of diversification on the performance of PE funds so far. Ljungqvist & Richardson (2003a) find no significant influences of diversification across the number of portfolio companies and industries on the internal rate of return (IRR) for their sample of mainly BO funds. Schmidt (2004) 2 A third group of articles studies the returns of publicly traded PE vehicles, which will not be further discussed in the scope of this article. For a recent study on publicly traded PE vehicles compare Zimmerman, Bilo, Christiophers & Degosciu (2005). 3 Additionally, Kaplan & Schoar (2005) and Kaserer & Diller (2004b find a performanc ...
This paper is the first systematic analysis of the impact of diversification on the performance of private equity funds. A unique data set allows the exact evaluation of diversification across the dimensions financing stages, industries, and countries. Very different levels of diversification can be observed across sample funds. While some funds are highly specialized others are highly diversified. The empirical results show that the rate of return of private equity funds declines with diversification across financing stages, but increases with diversification across industries. Accordingly, the fraction of portfolio companies which have a negative return or return nothing at all, increase with diversification across financing stages. Diversification across countries has no systematic effect on the performance of private equity funds.
This paper explores dynamic correlation and interdependence of five global REIT markets using multivariate wavelet methods. United States, Hong Kong, Belgium, South Africa and Australia’s daily REITs returns are used as proxies for North America, Asia, Europe, Africa and the Oceania continents, respectively. Highlights from our results indicate the following: First, almost a perfect market integration at long-run periods for the REIT markets is observed. However, such strong market correlations dissipate significantly to moderate and weaker linkages at the medium, and short-run periods, thereby showing possible diversification opportunities at the latter scales. The finding also signifies that global REITs linkages increases with investment horizons. Second, an interdependent global market is found, where well-developed REITs tend to lead/lag relatively smaller or less developed market (especially Africa’s REIT) across scales. Third, there are prospects of gaining higher expected daily returns per unit of risk from Europe and Asia’s REITs than all other markets. Though not totally integrated, there exist conspicuous evidence against a segmented global REIT market. Our findings are useful for improving portfolio selection and minimising trading risk.
This article demonstrates that increased inflows of capital into private equity and venture capital funds can influence the investment behaviour of fund managers by increasing staging intensity, increasing amount per financing round, and accelerating speed of capital allocation. These changes do not appear to be related to expectations of improved investment performance. The study extends the work of Gompers and Lerner who interpret these inflows as demand pressure for venture capital securities to drive up prices during periods of high inflows. Using a unique dataset, the study examines the effects of this pressure on investment behaviour.
We develop a new methodology to estimate the alpha and risk exposure of private equity funds. In contrast to existing work, our methodology mainly uses direct cash ow data and avoids the use of self-reported net asset values. Our GMM methodology is based on pricing restrictions for the cross-section of funds. We apply our methodology to a unique dataset comprising 23,296 cash-ows from 941 private equity funds between 1980 and 2003. We …nd a high market beta, especially for venture capital funds and report evidence that returns resemble those of long positions on call options. We also …nd evidence that venture capital funds loads positively on SMB and negatively on HML while buyout funds loads negatively on SMB and positively on HML. Only buyout funds are exposed to systematic liquidity risk.
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.
In this paper we show how cross-sectional correlations between Private Equity (PE) and Public Market Equity (PM) returns can be approximated, despite the lack of time series PE data. Based on a sample comprising 2,380 realized PE projects, we observe low cross-sectional correlations between PE and stock index returns (e.g. 0.18 for Nasdaq Composite Index). Despite overall low correlations, we find that investor can not benefit from a diversification effect when they really need it -during times of low PM returns. We point out differences between early and later stage PE investments regarding hedging capabilities triggered by distinct valuation approaches and exit channels. In PE, financial statements become more relevant for valuation purposes as firms mature. As early stage investors lack reliable fundamental information they rely more on comparable market valuation when pricing acquisitions. Furthermore, IPOs are their most important exit channel. In contrast, later stage investors price projects based on fundamental information and have better functioning alternative exit channels. They thus are less dependent on PM developments. We find significant statistical evidence for the negative correlation between early stage investments and excess returns over PM in bearish market conditions. Later stage investments exhibit a significant positive relation with excess returns over low PM returns. Investors seeking diversification benefits in PE should not solely rely on correlation coefficients, but need to carefully consider a fund's investment strategy. The conflict of objectives for Venture funds between active market timing and smoothing of PM returns is resolved in favor of active market timing. Buyout funds' returns are less dependent on PM developments and are thus the better complement for PM portfolios if investors seek diversification.
Acknowledgements: We would like to thank Daniel Schmidt, from CEPRES, for providing access to their databases. All remaining errors are of course are our own.
How can institutional and private investors safely invest into private equity funds? We provide a review of the private equity fund industry and a description of all the relevant management issues of fund investments, from an individual investment to a risk and portfolio management perspective. We also deal with indirect investment vehicles like funds of funds and securitised notes. This is the first book to discuss the relationship between the limited partners and the general partner and we aim to provide an undisguised and independent look behind the scenes, and explain the core aspects of this industry. A useful reference book for institutional practitioners, private equity fund managers and private equity lawyers, as well as students and academics who seek to understand the dynamics of the complex world of private equity funds.
The main purpose of this paper is to empirically model the influence of macroeconomic and financial variables on the performance
of risk capital in the US. We start our investigation using a static long-run equilibrium model. In contrast to previous studies,
we analyze the effect of several factors simultaneously within the framework of a vector error correction model (VECM). This
allows us to study short- and long-term interactions to overcome the problem of endogeneity, and to discover causal mechanisms.
The results show that the value of venture capital investments is positively related to industrial production, the exit channel
Nasdaq, and the long-term interest rate. However, the value of venture capital investments is negatively related to the short-term
interest rate. According to the short-term dynamics, VEC Granger causality confirms that only industrial production influences
venture capital performance, while venture capital returns Granger causes Nasdaq performance.
KeywordsVenture capital returns–Macroeconomy–Cointegration test–VECM–Granger causality–Variance decomposition
Abstract This paper investigates the potential benefits and limitations of equal and value-weighted diversification using as the example,the UK institutionalproperty market. To achieve this it uses the largest sample (392) of actual property returns that is currently available, over the period 1981 to 1996. To evaluate these issues two approaches are adopted; first, an analysis of the correlations
This paper provides an empirical analysis of risk handling arrangements adopted in the relationship between the venture capital investor and his investee. The theoretical framework adopted is principal-agent analysis, which views the investee as a risk averse agent entering into a risk sharing contract with the investor, a risk neutral Fully diversified) principal. The sample analysed is made up of twenty venture capital investors in the UK over the period 1992-93, and (where available) their corresponding investee(s). These investors accounted for about three-quarters of venture capital activity in the UK over this period. The paper reports on evidence gathered by semi-structured interviews with investors and investees, on expected returns, portfolio balance, screening and risk sharing.
The purpose of this research is to demonstrate a statistical technique, bootstrapping, and its application in estimating overall capitalization rates in real estate appraisal. This study compares bootstrapped statistics from real estate sample data with the actual sample statistics in order to determine if significant statistical differences are observed. In addition, the issue of how many minimum data points are required for bootstrapping to yield statistically valid proxies is presented.
This research examines the effects of diversification on the reduction of total portfolio risk in real estate investment trusts (REITs) and mixed-asset portfolios. In addition, overall performance measures are calculated and compared among REIT, common stock, and mixed-asset portfolios.
Executive Summary. The relatively low allocations to real estate in U.S. and U.K. institutional portfolios continues to conflict with those suggested by academic studies. Reasons put forward to explain the discrepancy have included the use of historic data, instead of expectations for the future; the use of smoothed real estate return indices, which underestimate the real estate risk/return relationship and differences in the amount of leverage used to finance real estate. Although these factors may provide some explanation for the allocation problem, they do not appear to fully explain the wide variations between theory and practice.
This study adopts a bootstrapping approach to derive ex-ante estimates of risk and correlations between common stocks and real estate for use in a mean-variance analysis. A dynamic optimisation approach is also undertaken by allowing the inputs to the model to vary. The effects that this has on optimal allocations to real estate in a two-asset portfolio are then explored. The impact of differences in portfolio size is also examined. A simulation model is estimated that shows it is possible to justify a wide range of allocations to real estate. The final choice of allocation depends upon the forecasting skill of real estate investors. If, on average, forecasting skill is poor, it can be shown that the low allocations observed in practice can be justified within a traditional risk/return framework. Introducing the possibility of investing in a riskless asset further justifies the current low allocations to real estate.
This study investigates primarily the relationship between portfolio size and the reduction of return variation in real estate portfolios and attempts to provide some notion of what represents an “adequate” level of naive diversification. The study also examines the proportional components of the total risk in real estate investment. The results provide information on the relative percentage of total risk accounted for by systematic or “market” factors.
An important step in long-horizon event studies is the choice of the benchmark that is used as a proxy for the expected return of the individual securities. Most existing studies use the rate of return of a stock market index. However, our simulation shows that such a procedure creates a significant bias in the means and in the test statistics. We simulate event studies by randomly choosing stocks out of a large database of historical rates of returns. The main results are: (1) Benchmarks should be selected by a simulation procedure before the design of a study is established in order to reduce potential bias. (2) Using reference portfolios that take account of return anomalies, and testing for long-run abnormal returns with bootstraped skewness-adjusted t-statistics lead to more precise results. (3) Misspecification due to time-varying return effects can be analyzed by the construction of random samples that share the same time distribution as the real events.
Thesis (D.B.A.)--University of Washington. Bibliography: l. 96-100.
During the past seven years, not everyone with equity holdings may have profited front the extraordinary bull market. Private investors with large concentrated holdings in only one or a few stocks are vulnerable to significant risk of underperforming. The author of this article provides a useful framework for explaining the risk-return benefits of adding stocks to a portfolio. The analysis uses Monte Carlo techniques to simulate total returns of equity portfolios with varying numbers of holdings for the seven-year period ending December 31, 1999. The universe is based on the original constituents of the Russell 1000 as of December 31, 1992, adjusted for survivorship. The results suggest significant risk reduction benefits can be achieved by adding only a small number of stocks to a nondiversified portfolio.
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).
Private equity is a critical asset that has become widely accepted as a key component of investment portfolios. Its major virtue is that it delivers attractive risk-adjusted returns with fairly low correlation to equities and bonds. Recent developments, however, imply that performance may be weak in the near future, particular for venture capital. This study employs mean-variance asset allocation to determine the optimum exposure to private equity. Specifically, long-run risk for private equity is compared to that for other assets, and assumptions regarding future performance are very conservative. Results demonstrate that substantial allocations to private equity are appropriate under a variety of alternative conditions.
We analyze the empirical power and specification of test statistics in event studies designed to detect long-run (one- to five-year) abnormal stock returns. We document that test statistics based on abnormal returns calculated using a reference portfolio, such as a market index, are misspecified (empirical rejection rates exceed theoretical rejection rates) and identify three reasons for this misspecification. We correct for the three identified sources of misspecification by matching sample firms to control firms of similar sizes and book-to-market ratios. This control firm approach yields well-specified test statistics in virtually all sampling situations considered.
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.
The paper explores factors that influence the design of financing contracts between venture capital investors and European venture capital funds. 122 Private Placement Memoranda and 46 Partnership Agreements are investigated in respect to the use of covenant restrictions and compensation schemes. The analysis focuses on the impact of two key factors: the reputation of VC-funds and changes in the overall demand for venture capital services. We find that established funds are more severely restricted by contractual covenants. This contradicts the conventional wisdom which assumes that established market participants care more about their reputation, have less incentive to behave opportunistically and therefore need less covenant restrictions. We also find that managers of established funds are more often obliged to invest own capital alongside with investors money. We interpret this as evidence that established funds have actually less reason to care about their reputation as compared to young funds. One reason for this surprising result could be that managers of established VC funds are older and closer to retirement and therefore put less weight on the effects of their actions on future business opportunities. We also explore the effects of venture capital supply on contract design. Gompers and Lerner (1996) show that VC-funds in the US are able to reduce the number of restrictive covenants in years with high supply of venture capital and interpret this as a result of increased bargaining power by VC-funds. We do not find similar evidence for Europe. Instead, we find that VC-funds receive less base compensation and higher performance related compensation in years with strong capital inflows into the VC industry. This may be interpreted as a signal of overconfidence: Strong investor demand seems to coincide with overoptimistic expectations by fund managers which make them willing to accept higher powered incentive schemes.
The Benchmark effect in long-run event studies Die Vertragsbeziehungen zwischen Investoren und Venture Capital Fonds: Eine empirische Untersuchung des europäischen Venture Capital Markt, CFS Working Paper, No
- O Ehrhardt
- R Koerstein
- S Feinendegen
- D M Schmidt
- M Wahrenburg
Ehrhardt, O. / Koerstein, R. (2001): The Benchmark effect in long-run event studies, OR Spectrum 23, pp. 445-475. r34 Feinendegen, S. / Schmidt, D.M. / Wahrenburg, M. (2002): Die Vertragsbeziehungen zwischen Investoren und Venture Capital Fonds: Eine empirische Untersuchung des europäischen Venture Capital Markt, CFS Working Paper, No. 2002/1 Fischer, L. / Lorie, J.H. (1970): Some Studies of Variability of Returns on Investments in Common Stocks, Board of Governors of the Federal Reserve System, Staff Studies No. 168
The Minimum Number of Stocks Needed for Diversification Private Equity Insights, Asset Allocation: A Framework for Private Equity
- G D Newbould
- P S Poon
Newbould, G.D. / Poon, P.S. (1993): The Minimum Number of Stocks Needed for Diversification, Financial Practice and Education, Vol. 3, pp. 85-87. r35 Pradhuman, S. / Kan, W. / Chbani, M. (2001): Private Equity Insights, Asset Allocation: A Framework for Private Equity, Merrill Lynch & Co, Global Securities Reserach & Economics Group
UK Venture Capital and Private Equity as an Asset Class for Institutional Investors
- O Burgel
Burgel, O. (1998): UK Venture Capital and Private Equity as an Asset Class for Institutional Investors, Research Report Foundation for Entrepreneurial Management, London Business School
The price of diversifiable risk in venture capital and private equity, Working Paper Columbia University Risk Metrics – Technical Document, Fourth Edition
- M C Jones
- Rhodes
- M Kropf
Jones, M.C. /Rhodes-Kropf, M. (2002): The price of diversifiable risk in venture capital and private equity, Working Paper Columbia University J.P.Morgan/Reuters (1996): Risk Metrics – Technical Document, Fourth Edition, New York Kallberg, J.G. / Liu, C.H. / Greig, D.W. (1996): The role of Real Estate in the Portfolio Allocation Process, Real Estate Economics, Vol. 24, No. 3, pp. 359-377
The Paradox of Private Equity Investing: Information or Diversification? in Quantitative Viewpoint Diversification in the Real Estate Portfolio
- Merrill Lynch
- M Mccue
Merrill Lynch, The Paradox of Private Equity Investing: Information or Diversification? in Quantitative Viewpoint (July 12, 1995) Miles, M. / McCue, T. (1984), Diversification in the Real Estate Portfolio, The Journal of Financial Research, Vol. 7, No. 1, pp. 57-68