David Bernard Munich, 23 February 2005 Thomson Venture Economics Benchmarking Private Equity T H O M…

David BernardMunich, 23 February 2005

Thomson Venture EconomicsBenchmarking Private Equity

T H O M S O N F I N A N C I A L

EVCA Institute - Financial Officer and Fund Administration Course

23 February 2005 2


Overview

• What are we measuring and why is it so difficult?

• What/how do we benchmark?

• What are the actual results for the industry?

23 February 2005 3


Current Environment

• Recent calls for more transparency as to how public pension funds private equity investments are doing (FOIA)

• What is the return being reported?

• How was it derived?

• How can you put it in context?

• Valuation guidelines (www.privateequityvaluation.com)

http://www.privateequityvaluation.com/


Part 1

What are we measuring and why is it so complicated?

23 February 2005 5


Is a return of 200% good enough?

• A return of 200%?– 200% total return: having invested €1, we get €2 back– 200% percentage change: we get €3 back (let’s assume this)

• Over what time period?– Over two years -- great at 73% per year (1.73^2=3)– Over ten? --- hmmm!! At 11.6% (1.116^10=3)

• Is it return on the investments the fund made or is it the return to the investors in the fund?

• Time Weighted/IRR/Realisation/Horizon?

23 February 2005 6


Why the difference with most stock indices?

• You can’t just look at the value at two points in time, i.e. today and some point in the past, with no transactions or cashflows in between – it would assume that you buy and hold

• You don’t invest the money all at once, you also take money out over a period of time

• So with investments either in private equity or any investment manager, if you have cashflows in and out of an investment, simple percentage change/total return calculations can no longer be done to get the true Return On Investment. So we turn to IRR, a form of ROI that takes the time value of money into account as it accounts for the timing of the transactions in the investment


Part 2

What/how do we benchmark?

23 February 2005 8


How do you put this fund return in context?

• Return is mathematical algorithm – it is an absolute measure

• Performance is a relative measure – can only be determined by comparing return to something else – for example past returns, benchmarks, etc.

• So you need a benchmark

23 February 2005 9


Why a benchmark: the Naïve Investor example

• Investor has choice of two investments

• Other things being equal, with no additional information – optimal allocation for naïve manager is 50-50

• So any decision you make different than this should be better performance – so benchmark is performance of 50-50 allocation

• So you are benchmarking the decision of the allocation

• That’s why public indices is used so often in stock market benchmarks – it’s the naïve manager decision

• Any investment decision you make different than allocation to S&P500 should be better if you are worth the fees you are being paid

23 February 2005 10


Whose decision are you benchmarking?

• Several decisions to benchmark for the LP investor– The allocation to private equity– The allocation between private equity sub asset classes– The temporal (timing) decision of when to invest– The decision of one manager over the other– (The investment decision of the fund)

23 February 2005


Principal benchmarks

• Cumulative IRR

• Cumulative Realisation Multiples (Cash-in/Cash-out)

• Time Weighted Return

• Investment Horizon Return

• Public Market Comparables – Index method

23 February 2005 12


Which benchmark to use – The LP Investor

• Benchmark the decisions under the control of the manager– If time is under control of the manager – timing of investments should be rewarded /

penalised – so use IRR – either cumulative or investment horizon– If time is not under control of the manager – use Time Weighted Return that takes time

out of the calculation of the benchmarks

• Several decisions to benchmark– The allocation to private equity – time weighted return– The allocation between private equity sub asset classes – time weighted return– The temporal (timing) decision of when to invest – investment horizon or cumulative IRR– Decision of one fund over the other – cumulative portfolio IRR*– The investment decisions of the fund – IRR/realisation by vintage year

* AIMR, GIPS, standard practice

23 February 2005 13


Some definitions (1/2)

Limited Partners

Private Equity Firm (General Partners)

Fund I Fund II

Company 1 Company 2

Cash take-downCash/stock distribution

• Takedown: actual money paid into partnerships, a.k.a. capital calls, paid in capital

• Distributions: cash or stock returned to LP investors

• NAV (net asset value*), a.k.a. residual value: ending value of the fund for the period being measured – net of management fees and carry

• Vintage Year: year fund started investing

• Pooled Return: portfolio return by pooling cashflows

Management fees

Carry

* as calculated and reported by the GPs

23 February 2005 14


Some definitions (2/2)

Best fund

Worst fund

IRRs in decreasing orderMaximum IRR

Upper Quartile

Median

Lower Quartile

Minimum IRR

Top Quarter

2nd Quarter

3rd Quarter

4th Quarter

…

23 February 2005 15


Fund Returns Calculations

Cash / stock returns to

investors = ‘Distribution’

Invested capital = ‘Paid-In’

time

• Principal metric is IRR since inception calculated net to limited partner. Beginning point is fixed, endpoint is variable

• The IRR is calculated as an annualised effective compounded rate of return using daily cash flows and annual/quarterly valuations. The IRR is the return (discount rate) that will equalise the present value of all invested capital with the present value of all returns, or where the net present value of all cash flows (positive and negative) is zero:

where CFi is the cash flow for period i (negative for takedowns, positive for distributions)

r -i

23 February 2005 16


Typical Fund Cashflow - Simple example of IRR calculation

Year Takedowns Distributions

NAV

1992 (5,201.8) 5,201.8

1993 (12,749.5) 17,300.2

1994 (15,299.4) 32,246.0

1995 (5,099.8) 7,988.0 49,128.1

1996 (5,099.8) 73,777.1

1997 (7,649.7) 30,770.5 66,416.4

1998 16,740.9 38,853.7

1999 11,484.7 25,046.8

-5.201.81 + IRR

+-12,749.5

(1 + IRR)2+

-15.299.4

(1 + IRR)3= 0

-5,099.8 + 7,988.0 + 49,128.1+

Column A

Row 1 (5,201.8)

Row 2 (12,749.5)

Row 3 (15,299.4)

Row 4 52,016.3

THE RAW DATA THE CALCULATION IN MS EXCEL

THE FORMULA

=irr(A1:A4,0)=28.9%

23 February 2005 17


Cashflows for Cumulative Returns

CF series to 1993

CF 1994 CF 1995 CF 1996 CF 1997 CF 1998 CF 1999

1992 (5,201.8) (5,201.8) (5,201.8) (5,201.8) (5,201.8) (5,201.8) (5,201.8)

1993 4,550.7 (12,749.5) (12,749.5) (12,749.5) (12,749.5) (12,749.5) (12,749.5)

1994 16,946.6 (15,299.4) (15,299.4) (15,299.4) (15,299.4) (15,299.4)

1995 52,016.3 2,888.2 2,888.2 2,888.2 2,888.2

1996 68,677.3 (5,099.8) (5,099.8) (5,099.8)

1997 89,537.2 23,120.8 23,120.8

1998 55,594.6 16,740.9

1999 36,531.5

IRR -12.5% -4.4% 28.9% 32.5% 29.4% 20.7% 17.9%

Series of actual annual cash flows with NAV added as a positive cash flow in last year17,300.2 -12,749.5

23 February 2005 18


Cumulative IRR Returns

DPI = Distributions / Paid In Ratio, a.k.a. realised multipleRVPI = Residual Value / Paid In Ratio, a.k.a. unrealised multipleTVPI = DPI + RVPI

Year Takedowns Distributions NAV Cumul IRR

DPI RVPI TVPI

1992 (5,201.8) 5,201.8 0 0.00 1.00 1.00

1993 (12,749.5) 17,300.2 -12.5% 0.00 0.96 0.96

1994 (15,299.4) 32,246.0 -4.4% 0.00 0.97 0.97

1995 (5,099.8) 7,988.0 49,128.1 28.9% 0.21 1.28 1.49

1996 (5,099.8) 73,777.1 32.5% 0.18 1.70 1.88

1997 (7,649.7) 30,770.5 66,416.4 29.4% 0.76 1.30 2.06

1998 16,740.9 38,853.7 20.7% 1.09 0.76 1.85

1999 11,484.7 25,046.8 17.9% 1.31 0.49 1.80

23 February 2005


Time Weighted Returns

• Time weighted return calculates a return for each period – quarterly, annually

• Beginning point is variable, endpoint is variable

• Calculate using net asset value at beginning and end of period and cashflows between periods

• Calculate IRR for each period and then compound together

• Shortfalls– Creates aberrations:

· 100 + 20% = 120· 120 - 20% = 96

– Returns heavily dependent on valuations. Wrong valuations affect future returns– Assumes money can come and go freely at the beginning and end of each

period



TWR = [(1+ret1)*(1+ret2)*(1+ret3)*(1+ret4)*(1+ret5)*(1+ret6)]^(1/6) - 1

1990 19941991 1992 1993 1994 1996

Ret 1

Ret 2

Ret 3

Ret 4

Ret 5

Ret 6

23 February 2005 21


Cashflows for Time Weighted Returns

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

1992 (5,201.8)

1993 4,550.7 (17,300.2)

1994 16,946.6 (32,246.0)

1995 52,016.3 (49,128.1)

1996 68,677.3 (73,777.1)

1997 89,537.2 (66,416.4)

1998 55,594.6 (38,853.7)

1999 36,531.5

TWR -12.5% -2.0% 61.3% 39.8% 21.4% -16.3% -6.0%

32,246.0 -15,299.4

23 February 2005 22


Year Takedowns Distributions NAV TWR Cumul total

return

Cumul annual return

1992 (5,201.8) 5,201.8 0 100% 0

1993 (12,749.5) 17,300.2 -13% 87% -13%

1994 (15,299.4) 32,246.0 -2% 86% -7%

1995 (5,099.8) 7,988.0 49,128.1 61% 138% 11%

1996 (5,099.8) 73,777.1 40% 193% 18%

1997 (7,649.7) 30,770.5 66,416.4 21% 235% 19%

1998 16,740.9 38,853.7 -16% 196% 12%

1999 11,484.7 25,046.8 -6% 185% 9%


23 February 2005 23


Investment Horizon Return

• Calculates backwards – what is the return over the last 1 year, 3 years, etc.

• Came about because some funds are quick out of the gate but LPs want to know – what have they done for me lately

• Indicates what impact overall market is having most recently

• Beginning point is variable and endpoint is fixed

• IRR is calculated for each “investment horizon”

• IRR is calculated net to limited partner

• Composites are calculated on a “pooled” basis as if from one investment


1990 19951991 1992 1993 1994 1996

Ret 1

Ret 2

Ret 3

Ret 4

Ret 5

Ret 6

Investment Horizon Return

23 February 2005 25


Cashflows for Horizon Returns

1-year 2-year 3-year 4-year 5-year 6-year 7-year

1992 (5,201.8)

1993 (17,300.2) (12,749.5)

1994 (32,246.0) (15,299.4) (15,299.4)

1995 (49,128.1) 2,888.2 2,888.2 2,888.2

1996 (73,777.1) (5,099.8) (5,099.8) (5,099.8) (5,099.8)

1997 (66,416.4) 23,120.8 23,120.8 23,120.8 23,120.8 23,120.8

1998 (38,853.7) 16,740.9 16,740.9 16,740.9 16,740.9 16,740.9 16,740.9

1999 36,531.5 36,531.5 36,531.5 36,531.5 36,531.5 36,531.5 36,531.5

-6.0% -12.2% 1.6% 11.9% 22.5% 19.2% 17.9%

Series of actual cash flows during the period, with NAV at the end added as a positive cash flow in last year, and NAV at the beginning added as a negative cash flow at beginning

11,484.7 +25,046.8

23 February 2005


So what do you have to ask to benchmark appropriately?

• Net IRR annualised since inception, net of fees and carried interest compounded at least quarterly, preferably daily

• The vintage year (be sure it agrees with Thomson Venture Economics’ vintage year – the year of the first capital call whether for investment or just management fees)

• Optional – total distributions, total paid in capital, ending NAV


Part 3

What are the actual results for the industry?

23 February 2005 28


Thomson Venture Economics Private Equity Performance Database

• Maintained by Venture Economics since 1988, online since 1991

• 1759 US Funds formed 1969-2004

• 880 European Funds 1980-2003

• 230 Other International Funds formed 1980-2003

• Available through Annual Benchmarks Reports & Online in VentureXpert, where you can define your own performance sample (by country, vintage, size, focus, etc.)

23 February 2005 29


23 February 2005


Sources

• 1/2 from partnerships on behalf institutional investor clients who contract our benchmarking services

• 1/2 directly from Partnerships who need data for their own benchmarking and fund raising needs

• Since we get data from LPs in addition to GPs there is not a consistent or significant self reporting bias

• We calculate IRR ourselves – do not use self-reported IRRs – use the underlying cashflows to calculate the return – verify against general partner financial reports to LPs

• We treat confidentiality very carefully – all data reported is strictly anonymous

23 February 2005 31


Example Vintage Year Performance BenchmarksAll European PE Funds Formed 1980-2003Returns Since Inception Net to Investors as of 31-Dec-2003

Vintage Number Average IRR

Pooled IRR

Max IRR Med IRR Pooled DPI

1980 3 10.3% 9.2% 13.0% 10.5% 2.00

1981 4 7.1% 8.6% 11.0% 6.3% 2.11

… … … … … … …

1999 91 -3.8% -2.8% 169.0% -1.6% 0.22

2000 117 -9.6% 1.5% 154.9% -11.3% 0.15

2001 65 -15.4% -11.7% 66.4% -12.1% 0.13

2002 33 -27.4% -13.7% 76.5% -19.5% 0.09

2003 18 -23.2% -14.6% 0.2% -2.5% 0.00

Source: Thomson Venture Economics (VentureXpert database)

23 February 2005


European Private EquityIRRs by Vintage Year as of 31-Dec-03

-20

-10

0

10

20

30

40

50

Vintage Year

Net

IRR

Sin

ce In

cept

ion

(%)

.

J-curve effect


23 February 2005


European Private EquityRealisation Multiples (DPI/RVPI) by Vintage Year

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Vintage Year

Tim

es in

vest

ed C

apita

l DPI RVPI


23 February 2005


European Private EquityAnnual Year to Year Returns (Time Weighted)

-40

-30

-20

-10

0

10

20

30

40

50

60

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Calendar Year

Ann

ual R

etur

n Ye

ar to

Yea

r (%

) Venture Buyouts


23 February 2005 35


Five Year Performance TrendsUS Venture vs. Buyouts as of 31-Dec-2003

-100

102030405060708090

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Year

5-ye

ar IR

R

All VentureAll BuyoutsAll Priv EquityS&P 500

Source: Thomson Financial

23 February 2005 36


Five Year Performance TrendsFirst Quartile Funds US Venture vs. Buyouts vs. stocks

-20

0

20

40

60

80

100

120

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Year

5-ye

ar IR

R

1st Quartile Venture1st Quartile Buyouts1st Quartile PEUS Large Stocks

Source: Thomson Financial

23 February 2005 37


US Private Equity Performance BenchmarksUS Limited Partnerships Formed 1969-2002Returns Since Inception Net to Investors as of 31-Dec-2003

Stage Number Pooled IRR Average DPI Std Deviation Manager Risk Coefficient

Seed Capital 63 10.5% 1.14 36.5% 3.5

Early Stage 463 20.7% 1.35 67.1% 3.2

Balanced 412 14.2% 1.16 27.4% 1.9

Later Stage 183 14.2% 1.04 31.0% 2.2

All Venture 1121 16.2% 1.20 48.7% 3.0

Buy-outs 0-$250m 176 24.6% 1.23 60.2% 2.5

Buy-outs $250-$500m 106 17.5% 1.06 38.6% 2.2

Buy-outs $500-$1bn 79 13.5% 0.86 21.9% 1.6

Buy-outs $1bn+ 100 8.5% 0.57 22.5% 2.6

All Buy-Outs 461 12.4% 0.73 37.2% 3.0

Mezzanine 63 9.6% 0.75 13.8% 1.4

All Private Equity 1715 14.0% 0.85 49.2% 3.5

Source: Thomson Financial’s VentureXpert database

23 February 2005 38


Comparators*Public Market EquivalentsReturns as of 31-Dec-2002

4.9 -0.1 -4.2 7.410.3 7.7 3.9 8.010.7 -0.2 -4.1 6.59.2 3.0 -1.3 7.3

12.9 -7.1 -8.7 4.010.0 7.1 0.3 7.710.8 -2.3 -5.7 7.2

Early stageDevelopmentBalanced

Since Inception Returns

StageEuropean Private

Equity ReturnMorgan Stanley

Euro IndexHSBC Small

Company indexJP Morgan EuroBonds

All VentureBuyoutsGeneralistAll Private Equity

*Comparators are Internal Rates of Return (IRR). IRRs for public market indices are calculated by investing the equivalent cashflows that were invested in private equity into the public market index. Then an equivalent IRR is calculated for each index.

23 February 2005


European vs. US Private EquityCumulative IRR Since Inception by Calendar Yearinception=31-Dec-1979

-5

0

5

10

15

20

25

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Calendar Year

Net

IRR

Sin

ce 3

1/12

/198

0 (%

)

US Europe


23 February 2005


European Private EquityFive Year Rolling IRRsFunds Formed 1980-2003

0

5

10

15

20

25

30

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Year

5 Yr

IRR

Venture

Buyouts


23 February 2005


European Private Equity Funds Formed 1980-2003Net Returns to Investors From Inception to 31-Dec-2003

Stage Number Pooled IRR

Upper Quartile

DPI RVPI TVPI

Early Stage 230 1.7% 5.3% 0.42 0.63 1.05

Development 161 9.1% 8.5% 0.79 0.69 1.48

Balanced 125 9.0% 11.2% 0.66 0.61 1.26

All Venture 516 7.2% 7.4% 0.62 0.64 1.25

Buy-Outs 291 12.5% 16.8% 0.65 0.68 1.34

Generalist 74 9.2% 6.9% 0.98 0.37 1.35

All Private Equity 881 10.0% 11.0% 0.71 0.61 1.32


23 February 2005


European Private Equity Funds Formed 1980-2003Net Investment Horizon Return as of 31-Dec-2003

1-year 3-year 5-year 10-year 20-year

Early Stage -13.6% -11.7% -2.1% 1.1% 1.7%

Development -7.3% -4.8% 4.7% 10.8% 9.1%

Balanced -5.2% -10.2% 4.3% 12.4% 9.0%

All Venture -7.8% -9.2% 2.3% 8.3% 7.2%

Buy-Outs 1.5% 1.6% 10.1% 13.1% 12.5%

Generalist 1.4% -10.4% 8.1% 14.7% 9.2%

All Private Equity -0.8% -3.5% 7.6% 12.1% 10.0%


23 February 2005 43


Want to know more?

• VentureXpert, the most complete private equity database globally (www.venturexpert.com)

– Profiles and directories (LPs, firms & funds, portfolio companies)– Analytics (includes investments, divestments, fund raising, fund performance)

• [email protected], +44 20 7336 1930

• For your data contributions and surveys: [email protected], +44 20 7014 1202

• www.thomson.com/financial

http://www.venturexpert.com/

mailto:[email protected]

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Documents

David Bernard Munich, 23 February 2005 Thomson Venture Economics Benchmarking Private Equity T H O M…