Risk in Private Equity - BVCA

1 Risk in Private Equity New insights into the risk of a portfolio of Private Equity funds ///// 1 Risk in Private EquityNew insights into the risk of a portfolio of Private Equity fundsOctober 2015Dr. Christian Diller,Dr. Christoph J ckel,Montana Capital Partners2 ///// Risk in Private Equity New insights into the risk of a portfolio of Private Equity funds BVCA Research Paper October 2015 About the authors: Many thanks:We would like to thank Pevera and Preqin for providing their datasets for this analysis.

2 We also would like to thank the BVCA Research committee as well as Gillian Brown (Rubato Associates) for their valuable comments to our paper. Disclaimer:The information contained in this report has been produced by the authors, mcp and BVCA, based on data from the BVCA, Pevera and Preqin and third parties information. While the authors, mcp and BVCA, have made every effort to ensure the reliability of the data included in this report, the organisations cannot guarantee the accuracy of the information collected and presented.

3 Therefore, the organisations cannot accept responsibility for any decision made or action taken based upon this report or the information provided here. This paper also does not represent any investment recommendation or any kind of advice to any institution or Christian Diller, PartnerChristian is a partner and co-founder of Montana Capital Partners AG, a Swiss investment advisor focussed on attractive niches of the secondary market with more than EUR 600 million Assets under Management as well as high quality asset management services for leading and sophisticated was previously Head of Solutions at Capital Dynamics leading the firm s structured activities with assets under management of more than USD 2 billion.

4 He also led the portfolio and risk management activities, advising some of the world s largest investors on asset allocation, portfolio rebalancing, cash flow planning and risk management in Private Equity . Prior to that, he worked in the asset management department covering strategic investments of Allianz Group in industrial, energy and healthcare companies. Before that, Christian was a buy-side analyst at Pioneer is chairman of the EVCA risk management committee developing guidelines for risk management models in Private Equity and was involved in discussions with European regulators on regulation of Private Equity under Basel III and Solvency II.

5 He regularly published in high - quality journals, co-authored a book on risk in illiquid assets and speaks at holds a Dr. rer. pol. in finance specializing on risk-/return characteristics of Private Equity funds from the Technical University Munich and a MSc from the Ludwig-Maximilian University Christoph J ckel, Vice PresidentChristoph is a Vice President of Montana Capital Partners AG. Christoph developed and implemented various risk management systems during advisory projects at large and sophisticated investors with multi-billion portfolios spread over developed and emerging markets.

6 He published articles in high quality scientific and practitioner s journals and presented at various joining mcp, Christoph was a research assistant at the Department of Financial Management and Capital Markets of the Technical University of Munich. His dissertation dealt with the computation and evaluation of alternative expected return proxies for stocks and was partly written during his stay as a Visiting Scholar at UCLA Anderson. In addition, Christoph gained international work experience at Kolbenschmidt Pierburg in Shanghai, Capital Dynamics in Zug, and Lehman Brothers in holds a Dr.

7 Rer. pol. in finance from the Technical University Munich and a diploma degree in business administration specializing on capital markets and operations research at the Technical University of Munich and at the National University of in Private Equity New insights into the risk of a portfolio of Private Equity funds ///// 11. IntroductionDue to the specific characteristics of Private Equity investments, the standard risk management tools that are used in other asset classes are unlikely to be applicable.

8 Instead, there are specific risks in Private Equity that an institutional investor should be aware of. In this study, we assess and measure the most significant risks in Private Equity , and examine in detail how these risks can be reduced. We contend that the most significant risks in the asset class are those of market risk, funding risk, liquidity and capital risk, and our empirical analysis of three different Private Equity datasets finds that both funding and capital risk can be substantially reduced through diversification.

9 In the study, we also measure Realisation Risk , an analysis on losing value from the point of observation until the end of fund s life, for the first time in a study on risk analysis in Private Equity . Our results demonstrate that the risk for an investor of losing any capital over the entire holding period with a portfolio of 20 funds is only , reducing to under 1% for an investor with a portfolio of 50 funds, adjusting for capital calls and distributions. These results demonstrate that Private Equity is not as risky as it is often perceived by some market participants, and that risk in the asset class should be conceptualised in a different way than it currently Private Equity has become an increasingly established asset class for institutional investors over recent decades, the issue of risk within the industry remains relatively underexplored.

10 Private Equity is a long-term asset class which generates strong returns for investors, and given the current low interest rate environment, may be particularly attractive to institutional investors who are seeking sustainable Some of the largest pension funds have had positive experiences with Private Equity since the early 1970s and have current Private Equity allocations of around 25%.2 Other long-term, non-regulated investors such as family offices sometimes have even higher allocations to the asset class with a Private Equity allocation comprising more than a third of their total While many of these sophisticated investors value the long-term risk-return characteristics of the asset class.