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On the Performance of Private Equity Investments: Does Market Timing matter?

Private equity plays an essential role for financing innovative companies and business sectors in the economy. These funds not only constitute an important source of financial funding but also represent a key monitoring device for young growth companies. Although research interest in private equity has increased remarkably during the last years, little is still known about the performance characteristics of private equity as an asset class. This paper attempts to fill this gap.

For mutual funds and hedge funds it is common practice to break down portfolio performance into two components: security selection and market timing. For private equity funds, portfolio performance has not been split up into company selection and overall market timing so far. However, it is generally assumed that venture capitalists have the ability to time the market for taking their portfolio companies public, and early research by Barry et al. (1990) and Lerner (1994) seems to indicate this. Casual observation tells that during the years of the technology bubble many private equity funds destroyed money, because they invested too late, at unreasonable valuation levels, and were too slow to exit their investments.

In a recent study, Ljungqvist and Richardson (2003a) show that there is high variation in the speed, with which funds draw down committed capital, and invest it deal by deal. Thus, although private equity funds do not invest into publicly traded assets and portfolio composition decisions are made less frequently, market timing supposedly plays an important role for overall fund performance.

The objective of this paper is to investigate the market timing abilities of private equity fund managers, using detailed cash flow information from a unique database of private equity funds. With timing ability we mean deal-by-deal investment timing ability of individual fund managers within the funds’ lifetime not entry timing of funds at the general industry level.

On the Performance of Private Equity Investments: Does Market Timing matter?