New research from the Luxembourg School of Finance, published today, has called into question the validity of investor belief in higher returns by investing in private equity investment funds.

The research, conducted by Dr Roman Kräussl of the Luxembourg School of Finance at the University of Luxembourg; Narashim Jegadeesh of Goizueta Business School, Emory University and NBER; and Joshua M. Pollet of the College of Business at the University of Illinois at Urbana-Champaign, suggests that the assumption of the higher profitability of private equity funds may be flawed.

Many investors believe that investing in funds which buy firms not listed on stock markets, otherwise known as private equity investment funds, hold more potential for higher returns rather than funds specialising in the investment of listed companies.

Large institutions and wealthy individuals have particularly favoured these private equity funds recently, in pursuit of high returns in an era of low interest rates. Whilst this concept has been supported by previous academic studies, the new research has deemed it questionable.

"Existing studies are susceptible to selection bias," commented Dr. Kräussl, explaining that "They rely on information reported by the funds' general partners or from large investors, but their experiences are often different from those of the typical private equity investor. We found a way to avoid this selection bias".

By studying the stock market performance of funds holding portfolios of private equity limited partnerships, Dr. Kräussl and his colleagues were able to determine a reliable proxy for measuring private equity investment returns and record firms' share prices fluctuating with the performance of their investment portfolios.

Employing this measure allowed the researchers to discover that expectations of long-term performance of private equity investments would vary little from the performance of normal stock market indices, between -0.5% and +2.0%. Expected returns are therefore very similar to those of holding listed securities on the major exchanges and the systematic risk of start-ups was found to be similar to investing in publicly traded stocks of small and medium-sized companies.

The paper is due to be published in the academic journal 'The Review of Financial Studies'.

 

Phooto by Michel Brumat / University of Luxembourg (Dr. Roman Kräussl)