The European private equity market had achieved a considerable volume until 2008. Reasons for increasing the volume can be seen in the favourable economic development, low inflation and strong competitive pressure on the part of financial intermediaries. These led to falling swap spreads on the financial markets and increased the investors’ risk tolerance.
Then, in September 2009, the investment business was depressed. The dreariness in the business with private equity participations or buy-outs could already clearly be read in the half-year figures on the market. The amounts invested also declined by just over one third.
Due to a lack of awareness, private equity is still frequently associated with high risk.
Investing in an individual company can sometimes be fraught with risk. Since private equity funds work in a highly specialised way and concentrate on specific sectors or industries, the investment in a single private equity fund can also be risky. The risk of default of an umbrella fund with investments in approx. 20 or more target funds, however, is very low due to broad diversification.
While additional costs are incurred for the investor for the services provided by the umbrella fund, the expected return is still clearly double-digit, even after subtracting these costs.
The average annual return on private equity is regularly 3 to 5% above the average annual yields of stock investments. Recent studies provide evidence that companies that were sold by private equity investors achieved an annual growth in value of 24% to 29% - comparable listed companies managed added value of only nine percent.
Private equity investments are investments in not listed companies with a high risk of default, low fungibility and transparency. A higher return on the investments is inevitably necessary – and feasible.
Table of Contents
1. Development of the private equity market volume
2. Situation of the private equity market in 2009-10
3. The performance [= “return”] of private equity
4. Features of the returns of private equity funds
5. Conclusion: Risk structure of private equity
Objectives and Topics
The work examines the performance characteristics and risk structures of the private equity asset class, analyzing market volume developments, investment returns, and the impact of fund structures on risk mitigation for investors.
- Analysis of European and US private equity market volume trends.
- Evaluation of performance metrics and yield comparisons against public stocks.
- Examination of the "J-curve" effect on fund lifecycle returns.
- Assessment of risk profiles across different private equity investment forms (direct vs. fund-of-funds).
- Investigation into the role of private equity in capital formation and value creation.
Excerpt from the Book
3. The performance [= “return”] of private equity
At the end of the 1990’s the first private equity umbrella funds were set up for private investors. By combining the investments of numerous private investors, the high mini-mum investment sums can be overcome. While in other countries, pension funds in particular have long been investing in this investment category, private equity has be-come more well-known in Germany only in the past ten years.
Due to this lack of awareness, private equity is still frequently associated with high risk.
On the one hand it is mistakenly equated with venture capital. The financing of young start-up companies, however, – as already described – represents only a sub-area of the private equity investment categories.
On the other hand, when assessing risk, general statements are often made without differentiating among the risk profiles of the individual investment forms – direct investment, funds and fund-of-funds.
Summary of Chapters
1. Development of the private equity market volume: This chapter highlights the disparity in market size between the European and US markets while exploring the impact of macroeconomic factors on transaction volumes.
2. Situation of the private equity market in 2009-10: The author discusses the sharp decline in investment activities and transaction values in Germany following the financial crisis.
3. The performance [= “return”] of private equity: This section clarifies the definition of private equity, addresses common misconceptions regarding risk, and compares its historical returns to those of public market equities.
4. Features of the returns of private equity funds: This chapter explains the mechanics of fund life cycles, specifically the J-curve effect, and how long-term performance remains stable despite short-term market fluctuations.
5. Conclusion: Risk structure of private equity: The final chapter summarizes how different fund structures, particularly fund-of-funds, serve to significantly mitigate the default risks associated with individual private equity investments.
Keywords
Private Equity, Market Volume, Investment Returns, Venture Capital, Buyouts, Risk Management, Portfolio Theory, J-Curve, Fund-of-Funds, Capital Formation, Asset Classes, Financial Markets, Leverage Effect, EBITDA, Investment Performance.
Frequently Asked Questions
What is the core focus of this publication?
The work provides an analytical overview of the private equity asset class, specifically focusing on how returns have historically developed and how different investment structures impact risk.
What are the primary thematic areas covered?
The main themes include market volume growth, the comparison between private equity and public company returns, the impact of the J-curve on fund performance, and the risk mitigation achieved through diversified fund structures.
What is the main research goal?
The goal is to demystify private equity performance and provide a realistic assessment of its risk-return profile, correcting common misconceptions that equate it solely with high-risk venture capital.
Which scientific approach is utilized?
The author uses empirical market data and comparative performance analysis to evaluate value growth and risk profiles, supported by studies from financial institutions and industry experts.
What topics are discussed in the main body?
The main body covers the development of the private equity market, the impact of economic crises on transaction volumes, the specific performance of various fund types, and the application of portfolio theory to private equity.
Which keywords characterize this document?
Key terms include Private Equity, Market Volume, Investment Returns, Risk Management, and Portfolio Theory.
How does the "J-curve" affect private equity investors?
The J-curve describes the phenomenon where funds initially experience negative cash flows due to investment costs, with returns increasing significantly only in the later stages of the fund's lifecycle.
Why is the risk lower for fund-of-funds compared to direct investment?
Risk is lower in a fund-of-funds because the capital is diversified across a large number of target funds and sectors, which significantly reduces the probability of a total default compared to investing in a single company.
- Quote paper
- Jörg Eschmann (Author), 2010, The performance of private equity, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/162785
