Is private equity performance persistence related to the skill of fund managers and which other factors may explain it?

Abstract

Whether fund managers have skill in managing their portfolios, and whether this skill allows them to persistently generate superior returns for investors are crucial questions for investors’ capital allocation decisions. In this thesis, we study performance persistence in private equity and investigate the relationship between skill and persistence, as well as look into other factors that may affect this relationship. We find that that there is persistence for the first follow-on fund, but it decreases drastically already from the second follow-on fund. When tested for the similarity of market conditions, it does not help to explain persistence. Therefore, short-term persistence may be attributed to the skill of general partners. The lack of long-term persistence may be explained by the decreasing returns to scale. This factor is especially strong in eroding performance persistence in venture capital funds, while the managers of buyout funds seem to have more scalable skills. Finally, persistence is stronger for worse performing funds. This, however, does not necessarily mean the lack of skill of good-performing managers. It can also mean that they are backed by sophisticated investors who make more informed capital allocation decisions and cause the flow of funds to decrease performance persistence due to the diseconomies of scale. Overall, the findings are not conclusive about the skill of fund managers due to the limitations of this work. However, they shed light on some important considerations for investors and provide grounds for further research.