Working Paper: NBER ID: w19612
Authors: Morten Sorensen; Neng Wang; Jinqiang Yang
Abstract: We investigate whether the performance of Private Equity (PE) investments is sufficient to compensate investors (LPs) for risk, long-term illiquidity, management and incentive fees charged by the general partner (GP). We analyze the LP's portfolio-choice problem and find that management fees, carried interest and illiquidity are costly, and GPs must generate substantial alpha to compensate LPs for bearing these costs. Debt is cheap and reduces these costs, potentially explaining the high leverage of buyout transactions. Conventional interpretations of PE performance measures appear optimistic. On average, LPs may just break even, net of management fees, carry, risk, and costs of illiquidity.
Keywords: Private Equity; Performance; Investment; Limited Partners; General Partners
JEL Codes: G11; G2; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| management fees, carried interest, and illiquidity (G19) | LPs' costs (J32) |
| GPs must generate substantial alpha (E13) | compensate LPs for costs (J30) |
| debt (H63) | LPs' costs (J32) |
| leverage (G24) | breakeven alpha required (G12) |
| total costs of PE investments (G31) | LPs' compensation (J33) |
| conventional interpretations of PE performance measures (L25) | LPs' compensation sufficiency (J33) |