5 Ways to Predict a ‘Loser’ Fund

Private equity has always suffered from Lake Wobegon syndrome—ask any manager about their fund’s performance and you’ll find that every fund is “above average.”

While investors know that can’t be true, it doesn’t make picking winners any easier. But based on research from Pantheon, it does appear that after an investment it’s possible to make a good guess about a fund’s performance based on its early success (or lack thereof), and the speed with which it clears a carry hurdle (if it does at all).

Pantheon’s findings take on particular significance given the maturation of the secondaries market, which makes pruning a portfolio of underperforming funds more efficient than ever. And the quicker you can identify a long-term loser, the quicker you can identify another investor to take it off your hands.

Here are the five key findings for buyout funds from the Pantheon research that was based on historical performance data from 700 private equity buyout and venture funds:

1. For funds between seven and 10 years old, the median incremental IRR of those that had cleared the carry threshold was statistically higher than those that had not. Specifically, those in carry at year nine generated at least an extra 3 percent of incremental IRR.

2. A fund’s vintage has little bearing on the outcome—when separated by vintage cohorts “in- carry” funds still statistically outperform.

3. By year five, buyout funds in the top quartile have less than a 13 percent probability of final performance below that of the median fund.

4. By year five, a top quartile fund has a 60 percent probability of remaining top quartile by the time it crystallizes all—or a majority of—its aggregate returns. Even at year four, which is still within most funds’ investment periods, the probability is 50 percent.

5. By its third anniversary, a buyout fund in the bottom quartile has less than a 27 percent probability of performing above the median.

You can download the full paper here.