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Private Equity Performance Analysis in R

PrivateEquityPerformanceAnalysisinRKarlP olenR/Finance2014 KarlPolenPrivateEquityPerformanceAnalysi sinRWhatisprivateequity?PrivateEquity( PE )involvesinvestingincompaniesthatarenotl istedonapublicsto ckexchangePEinvestmentsgenerallytakethef ormofalimitedpartnershipinterestinapartn ership,usuallycalleda fund Atypicalfundwillinvestinaroundtencompani esPEinvestsinsituationswherethereisavalu eaddopp ortunityfromgrowth,restructuring,acquisi tionsandothersuchstrategiesKarlPolenPriv ateEquityPerformanceAnalysisinRPerforman ceMeasurementIssueBecauseoftheilliquidit yandrisksasso ciatedwiththevaluecreationstrategies,PEi nvestorsgenerallyexp ecttoearnareturnpremiumcomparedtopublicm arketsHowever.

Karl Polen Private Equity Performance Analysis in R. Determining a Market Return from Direct Alpha For consistency with the capital asset pricing model Direct ... Benchmarking private equity: The direct alpha method. Available at SSRN , 2014. Steven N. Kaplan and Antoinette Schoar.

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Transcription of Private Equity Performance Analysis in R

1 PrivateEquityPerformanceAnalysisinRKarlP olenR/Finance2014 KarlPolenPrivateEquityPerformanceAnalysi sinRWhatisprivateequity?PrivateEquity( PE )involvesinvestingincompaniesthatarenotl istedonapublicsto ckexchangePEinvestmentsgenerallytakethef ormofalimitedpartnershipinterestinapartn ership,usuallycalleda fund Atypicalfundwillinvestinaroundtencompani esPEinvestsinsituationswherethereisavalu eaddopp ortunityfromgrowth,restructuring,acquisi tionsandothersuchstrategiesKarlPolenPriv ateEquityPerformanceAnalysisinRPerforman ceMeasurementIssueBecauseoftheilliquidit yandrisksasso ciatedwiththevaluecreationstrategies,PEi nvestorsgenerallyexp ecttoearnareturnpremiumcomparedtopublicm arketsHowever.

2 PEinvestmentsvaryinamountovertimeb ecausethePEinvestordrawsthecapitaloverth e rst3to5yearsofthepartnershipandthensells theinvestmentsovertheremaining5to7yearsT hiscreatesachallengeinassessingp erformanceincomparisontopublicmarketretu rnsb ecauseb ecauseIRRscalculatedonPEcash owsarenotcomparabletotimeweightedreturns ( TWR )onpublicmarketsinvestmentsKarlPolenPriv ateEquityPerformanceAnalysisinRTradition alPerformanceMeasurementsWecananalyzethe p erformanceofafundfromthefollowingdatathe timeseriesofcapitalcallsCtthetimeserieso fdistributionsDttheremainingunrealizedva lueattimenoftheinvestmentVnThedistributi onsasp ercentofinvested( DPI )is Dt CTThetotalvalueasp ercentofinvested( TVPI )is Dt+Vn CTTheIRRiscalculatedfromthecalls(asnegat ivenumb ers),thedistributionsandthe nalvalueIRR( Ct,Dt,Vn)

3 KarlPolenPrivateEquityPerformanceAnalysi sinRHowtocalculateanIRRAnIRRisfoundbycal culatingthero otofap olynomial ni=0cixiwherecarethecash owco e cientsandxis11+irrYoucanuseuniro otorp olyro ottocalculatetheanswerinRButyouneedawayt oselectamongmultiplero otsAnditturnsoutthereareproblemsinapro ductionenvironmentwithlongcash owtimeseries(hundredsofentries)withmanys ignchangesIdemonstrateco olen/15756 KarlPolenPrivateEquityPerformanceAnalysi sinRPublicMarketEquivalentMeasuresThetra ditionalp erformancemeasuresofIRR,DPIandTVPI provideusefulto olstounderstandthep erformanceofaparticularinvestmentButthey don'tprovideareliablewaytocompareprivate equityinvestmentswithpublicmarketindices NordotheyprovideareliablewaytocomparePEi nvestmentstoeachotherb ecausethetimingandmarketcontextofdeploym entcanb equitedi erent.

4 EvenamongfundsofthesamevintageSotherewer eanumb erofe ortsthatattemptedtocalculateab enchmarkpublicmarketreturnasthoughyoumad einvestmentsandwithdrawalsfromthepublicm arketp ortfoliointhesamepatternastheprivateequi tyinvestmentSuchmetho dsarereferredtoas PME Wewilldiscusstwosuchmetho dshereKarlPolenPrivateEquityPerformanceA nalysisinRKaplanSchoarSteveKaplanandAnto inetteSchoarprop osedametho dforcalculatingPMEthatwewillrefertoas KSPME [2]Inthisapproach,youcalculatearatiowher ethenumeratoristhewealthyouhavefromthedi stributionsyoureceivefromaPEasifinvested inthepublicmarketindexandhelduntiltimena ndthedenominatoristhewealthyouwouldhaveh adyouinvestedthecapitalthatwascalledfort hePEinvestmentinthesto ckmarket,instead,andheldituntiltimenValu esofthisratiogreaterthanoneindicatethepr ivateequityinvestmentoutp erformedthepublicmarketindexKarlPolenPri vateEquityPerformanceAnalysisinRKaplanSc hoar(2)

5 So,KSPME requiresadditionaldataofvaluesofadividen dadjustedindexMtYouthencalculateafactort oconvertcash owstotheirvalueattimenasFVt=MnMtNextyouc alculatethefuturevaluesofCtandDtasCFV=Ct FVt;DFV=Dt FVtYoucannowcalculateKSPME= DFV+Vn CFVKarlPolenPrivateEquityPerformanceAnal ysisinRDirectAlphaKSPME providesawealthmeasureofhowmuchextramone yyoumade,butdo esn'ttellyouhowfastyoumadeitGredil,Gri thsandStuckehaveprop osedametho dcalled DirectAlpha toexpresstheoutp erformanceasanannualrateofreturn[1]Thisc alculationworksfromexactlythesamedataasK SPMED irectAlphaiscalculatedastheIRRofatimeser iesconstructedbycombiningthefuturevaluea djustedcalls(asnegativenumb ers),distributionsandthe nalvalueDirectAlpha=log(1+IRR( CFV,DFV,Vn))

6 KarlPolenPrivateEquityPerformanceAnalysi sinRDeterminingaMarketReturnfromDirectAl phaForconsistencywiththecapitalassetpric ingmo delDirectAlphaisstatedascontinuouslycomp oundedreturnForaPEinvestmentwithanintern alrateofreturnofIRRPE youcancalculateanequivalentIRRforaninves tmentinpublicmarketsIRRM aslog(1+IRRM) =log(1+IRRPE) DirectAlphaKarlPolenPrivateEquityPerform anceAnalysisinRExampleCalculationCo deandarealisticdata leforahyp otheticalprivateequityp olen/pme-calcsIdescrib ethecalculationsandhowtousetheco olen/16062 Sampleoutputfromthisco > < PME < < PME < < PME < < . ReturnFund IRRP rivate Equity PerformanceKarlPolenPrivateEquityPerform anceAnalysisinRFormoreinformationHereisa summaryofthelinkspreviouslymentionedTech nicalitiesofCalculatingIRRsinapro olen/15756 MorebackgroundonPEp olen/16062 Sourceanddata olen/pme-calcsKarlPolenPrivateEquityPerf ormanceAnalysisinRReferencesOlegGredil,B arryEGri ths, :Thedirectalphametho , erformance:Returns,p ersistanceandcapital ,60(4).

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