Varieties of Funds and Performance: The Case of Private Equity

Within the growing body of literature on private equity, there is intense debate as to whether, and by how much, the industry really adds value. However, much of the diversity in results can be ascribed to a tendency to combine very different fund types. This study explores variations in performance according to fourteen different types of fund, a much bigger range than preceding studies in the academic literature. We find that funds that focus on riskier areas of activity are not only are associated with divergent outcomes, but generally underperform. In other words, there is variety in degree of underperformance, but in general, high risk is married with poor returns. We explore why such funds continue to attract significant investment. Since the wave of post-financial crisis quantitative easing, there has been a growing divergence between multiples of invested capital and internal rates of return, with the former doing significantly worse than the latter, suggesting possible changes in funds’ holding period strategies and, possibly, that it has become harder to optimise returns other than through borrowing. However, there is much more to fund performance than potential risk and debt, and evaluate which specific types of fund do better or worse when, and why, as well as which types of fund are associated with greater unpredictability in returns. We apply agency theory to help understand general partner behavior in private equity partnerships, and draw on the literature on the economics of expectation and of systemic evolution to explain limited partner behavior, and draw out the implications for theory and practice.