Derechos Humanos y Derechos del Niño [y la Niña]

As anticipated, funds’ performance calculated using IRR cannot be directly compared to public markets returns, since substantial differences among valuation methods exist. Instead, adjusted calculations need to be carried out to make such a

69 _{In particular, money-weighted rates of return are more likely to generate distortions, as a capital} contribution would enhance the rate even if the manager has performed poorly; conversely, a capital distribution would lower the rate, even if the manager has performed well, impairing its results.

64 | P a g .

comparison effective, and this is what Public Market Equivalents (PMEs) have been created for. Notably, PMEs include a set of different ratios mainly created by academics that, by mixing components of both return valuation methodologies, make it possible to assess private equity performance against those of public markets. To do so, some of the most significant worldwide public indices are used as benchmarks, with regard to the S&P500, the NASDAQ, the Russell 3000, the J.P. Morgan Government bond index, the MSCI Europe for large-cap companies; the Russell 2000, the Fama French small-cap index and DFA microcap for small- to mid-cap companies70_.

So far, six PME methodologies have been successfully developed, as reported in Table 4.

PME

Long Nickels PME+ Modified PME

Kaplan-Schoar Alpha (Excess IRR) Direct Alpha

Table 5 – Relative performance (PMEs)

Being a comprehensive quantitative analysis of each of these PMEs beyond the scope of this work, within this thesis we will mainly refer to the most overall utilized, namely, Kaplan-Schoar (KS-PME) and the Alpha.

KS-PME was first created and used on the related paper of these authors71_{, and it}

is essentially a multiple. It divides discounted distributions to investors by discounted contributions to the fund over the entire fund’s life, and a public benchmark (usually, S&P500) is used as the discount rate (i). Note the formula:

𝐾𝑆 − 𝑃𝑀𝐸 = ∑ 𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛𝑠𝑡 (1 + 𝑖)𝑡 𝑛 𝑡=0 ∑ 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛𝑠𝑡 (1 + 𝑖)𝑡 𝑛 𝑡=0

70 _{The first set of indices (large-cap) is overall used with correlated large and megadeals (over $500m),} whereas the second set is used to compare performances of smaller LBO deals against performances of small- and mid-cap publicly held companies.

71 _{Kaplan, S.N. and Schoar, A. (2005), “Private Equity Performance: Returns, Persistence and Capital} Flows”, The Journal of Finance, Vol. 60, No. 4

65 | P a g .

Being it a multiple, a value greater than 1 indicates outperformance of the fund over the public benchmark, and vice versa.

Alpha (or Excess IRR), by contrast, compares IRR of a fund with an adjusted-IRR computed for a specific public benchmark. If the fund’s IRR is greater than the adjusted-IRR (Alpha > 0), that means outperformance of the fund over the public markets, and, conversely, if the fund’s IRR is found to be lower than its public counterpart’s, it means underperformance of the fund.

1.5.2.6 LBO vs. public markets: superior returns?

We will conclude Part I by analyzing existent literature related to whether investing in leveraged buyouts have hitherto led to superior returns, comparing them to those achieved in public markets. Being LBOs an alternative class of investments, with higher levels of risk and costs in general, we would expect to find consistent outperformance public markets returns, otherwise having no rational reason for allocating capital in such a riskier way. As already said, authors use important large-cap indexes of the most relevant stock exchanges on a worldwide basis, sometimes drawing on indexes that reflect performance of small- to mid-cap companies for smaller LBOs, with the aim of offsetting the basis for comparison. Therefore, while the S&P500 index is the most widely used for US markets, MSCI Europe and other major indexes are used for the European context; nonetheless, we will signal should authors use different indices in their research. We will split this subsection in two parts: the first is aimed at analyzing prior research on LBO performance from the 1980s up to the early 2000s, while the second, besides expanding the performance analysis for more recent times, contains adjustments with regard to previous literature.

During the 2000s, substantial research was done to assess whether LBO returns were high enough to overcome public markets ones. Several authoritative scholars

66 | P a g .

carried out studies that mainly relied on Venture Economic-based samples of companies, and results were not always concordant. To begin with, Kaplan and Schoar72 _{were among the firsts who attempted to assess LBO performance, using}

a sample of US-based funds raised between 1980 and 2001. One of the most relevant contribution they provided was to create a new PME (i.e., Public Market Equivalent) in order to contrast LBO returns with those achievable in stock exchanges. By means of their KS-PME, thus, they found that the LBO market outperformed public markets on a gross-of-fees basis, whereas returns were roughly the same if LBO profits were considered net of fees. Similarly, Lyungqvist and Richardson73 based their research on a sample of funds in which a large LP invested in during the period 1980-1993, and they found excess returns of such funds over the S&P500 of 5% to 8% per annum. Nevertheless, not all findings used to display such optimistic results. For all, Phalippou and Gottschalg74 disagreed on alleged positive returns that had been reported, and they built a model in which performance of LBOs were adjusted on three corrections75 _{to better offset}

returns against costs. Hence, they proceeded to compare LBO and S&P500 performances by using the Alpha PME, and they found that, with three corrections applied, gross-of-fees LBO returns roughly equaled public markets ones, while there was an yearly underperformance of -6% on a net-of-fees basis.

As for European LBOs, Kaserer and Diller76 _{analyzed a sample of almost 800 EU-}

based funds raised between 1980 and 2003 and found superior LBO performance over the MSCI Europe equity index and the J.P. Morgan Government bond index by using both absolute and relative performance metrics.

72 _{Kaplan, S.N. and Schoar, A. (2005), “Private Equity Performance: Returns, Persistence and Capital} Flows”, The Journal of Finance, Vol. 60, No. 4

73 _{Lyungqvist, A. and Richardson, M. (2003), “The Cash Flow, Return and Risk Characteristics of Private} Equity”, available at: http://archive.nyu.edu/bitstream/2451/26715/2/S-CG-03-01.pdf (accessed January 2016)

74 _{Phalippou, L. and Gottschalg, O. (2009), “The Performance of Private Equity Funds”, The Review of} Financial Studies, Vol. 22, No. 4

75 _{The three corrections introduced by the authors refer to: a) writing off NAVs; b) changing the} weighting scheme from capital commitment to present value of invested capital; c) inclusion of projected PI for additional funds.

76 _{Kaserer, C. and Diller, C. (2004), “European Private Equity Funds – a Cash Flow Based Performance} Analysis”, available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=547142 (accessed January 2016)

67 | P a g .

Regardless of results shown by early literature, the same and other authors have recently found the Venture Economics dataset to have downward biased LBO performance and, as a consequence, results provided in prior research were incorrect and misleading. Therefore, a new wave of research papers and articles have consequently come, relying on new and unbiased data derived from datasets like Burgiss, Preqin and Cambridge Associates. Many authors have been engaged in revisiting older findings, to evaluate what performance of LBOs really were. Results are spectacularly positive so far: almost any scholar agrees with others on reporting incredibly higher returns than those of prior literature. In particular, Kaplan et al. (2014)77 _{report an outperformance of LBOs over public markets of}

20% to 27% over the whole fund’s life, matching a mean 3.7% on an annual basis and considering net-of-fees returns. Consistently with them, Phalippou78 finds outstanding returns as well, reporting that, out of 10 LBO investments, 2.5 are “homeruns” (IRR > 50%), 5 exhibit an IRR between 0 and 50%, while 2.5 lose all or part of their money (with 1 in 10 being a complete bust). Regardless, in another paper79_{, the author claims that the large majority of buyout transactions have had}

an average deal value of $302m, hence small-cap indices should be used to compare LBO returns with stock exchange ones, and the Fama-French and the DFA- microcap would represent a better choice rather than large-cap S&P500 and NASDAQ. Applying this correction, the author finds that LBO performance approximately matches public markets ones, showing PMEs multiples roughly equal to 1.

Again, Mozes and Fiore80 _{acknowledge possible evaluation problems of IRR as a}

performance metric, so that they correct it by applying some adjustments that

77 _{Harris, R.S., Jenkinson, T., and Kaplan, S.N. (2014), “Private Equity Performance: What Do We Know?”,} The Journal of Finance, Vol. 69, No. 5

78 _{Lopez-de-Silanes, F., Phalippou, L. and Gottschalg, O. (2015), “Giants at the Gate: Investment Returns} and Diseconomies of Scale in Private Equity”, Journal of Financial & Quantitative Analysis, Vol. 50, No. 3 79 _{Phalippou, L. (2014), “Performance of Buyout Funds Revisited?”, Review of Finance, Vol. 18, No. 1} 80 _{Mozes, H.A. and Fiore, A. (2012), “Private Equity Performance: Better than Commonly Believed”,} Journal of Private Equity, Vol. 15, No. 3

68 | P a g .

would likely impair LBO returns. Nonetheless, they find strong outperformance over stock exchanges returns even on a net-of-fees basis.

The conclusion towards which any scholar seems to be heading, however, is that

leveraged buyout funds have overall generated returns with a risk-reward profile superior to that of public equities.

69 | P a g .