The End of Persistence? What Research Tells Us About Private Equity Performance

A groundbreaking study by researchers from the University of Virginia, University of Oxford, University of Chicago, and Warburg Pincus has important implications for how investors should think about selecting private equity funds. The research, which analyzes over 2,200 buyout and venture capital funds, challenges some long-held beliefs about performance persistence in private equity while confirming others.

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The Conventional Wisdom Gets Challenged

For years, the conventional wisdom in private equity has been straightforward: invest with top-performing managers who have proven track records, and avoid first-time funds. This belief was supported by academic research from the 1980s and 1990s showing strong performance persistence - managers who performed well in one fund tended to perform well in their next fund.

However, this new research reveals that for buyout funds raised after 2000, past performance is no longer a reliable predictor of future success. When looking at the information investors actually had available at the time they needed to make investment decisions, there was little evidence that picking managers based on their previous fund's performance led to better results.

A Tale of Two Strategies: Buyout vs Venture Capital

One of the study's most interesting findings is the stark difference between buyout and venture capital funds:

For Buyout Funds:

• Performance persistence has largely disappeared post-2000

• Top-quartile performance rarely repeats

• First-time funds actually perform as well as established managers

• All quartiles of funds tend to outperform public markets

For Venture Capital Funds:

• Strong persistence continues to exist

• Top performers are more likely to remain top performers

• The conventional wisdom about backing established managers still holds

• Both top and second quartile funds consistently beat public markets

Why the Difference?

The researchers suggest a few potential explanations for why buyout persistence has disappeared while venture persistence remains. The buyout industry has matured and become more competitive, with managers learning from each other and adopting similar operational improvement techniques. In contrast, venture capital success may rely more on hard-to-replicate networks and pattern recognition skills that create sustainable advantages.

Implications for Investors

This research has several important implications for private equity investors:

For Buyout Investments:

1. Don't rely too heavily on past performance when selecting managers

2. Consider first-time funds, which perform surprisingly well

3. Focus more on a manager's specific strategy and capabilities rather than track record

4. Avoid only funds with bottom-quartile previous performance

   
   

For Venture Capital Investments:

1. Continue to prioritize access to established top-performing managers

2. Be willing to back second-quartile performers, who also tend to outperform

3. Maintain long-term relationships with successful venture firms

4. Be more cautious about first-time funds

   
   

A New Model for Due Diligence

The findings suggest investors need to evolve their due diligence approach, particularly for buyout funds. Rather than simply targeting previous top-quartile performers, investors should focus more on:

• Understanding a manager's specific operational capabilities

• Evaluating their deal sourcing advantages

• Assessing their ability to add value to portfolio companies

• Analyzing their strategy in the current market environment

The Future of Private Equity

This research highlights how the private equity industry continues to evolve. As the buyout sector has matured, historical performance has become less predictive of future success. This suggests the industry may be becoming more efficient, with fewer managers able to maintain persistent advantages over their peers.

However, the continued persistence in venture capital returns reminds us that some aspects of private equity investing still reward specialized expertise and hard-to-replicate capabilities. The key for investors is understanding these dynamics and adjusting their investment approach accordingly.

The bottom line? The old rules don't all apply anymore. Successful private equity investing requires a more nuanced approach that goes beyond simply backing last decade's winners. In today's market, thorough due diligence and forward-looking analysis matter more than ever.

Harris, Robert S., Tim Jenkinson, Steven N. Kaplan, and Ruediger Stucke. 2020. "Has Persistence Persisted in Private Equity? Evidence from Buyout and Venture Capital Funds." NBER Working Paper No. 28109.
For those wanting to access the paper, it was released as a National Bureau of Economic Research (NBER) working paper in November 2020 and can be found at http://www.nber.org/papers/w28109, though note that NBER working papers typically require a subscription or institutional access.
The authors are affiliated with:

Robert S. Harris: University of Virginia, Darden School of Business
Tim Jenkinson: University of Oxford, Said Business School
Steven N. Kaplan: University of Chicago, Booth School of Business
Ruediger Stucke: Warburg Pincus LLC

The research was supported by the UAI Foundation and the Center for Research in Security Prices. The dataset used came from Burgiss, a provider of private equity data and analytics.