Working Paper: NBER ID: w31664
Authors: Gregory W. Brown; Celine Yue Fei; David T. Robinson
Abstract: General Partners (GPs) in private equity face a trade-off between focusing their skills and effort on fewer investments to earn higher returns, or investing more broadly to reduce risk through diversification. Using a novel, deal-level dataset of 5,925 global investments from 1999 to 2016, we show that these portfolio considerations are important for understanding fund-level private equity returns. The largest investments in PE funds typically have the lowest returns on average, but are also the least risky. Returns and risk are both increasing in industry or geographic concentration. And while GP-specific return variation (e.g., skill) only accounts for 4%-6% of the total return variation of a typical investment, it accounts for around 40% of the return variation at the fund level. These findings show that GPs use portfolio construction, and not just deal selection, to seek risk-adjusted fund-level returns.
Keywords: private equity; portfolio management; investment behavior
JEL Codes: G10; G11; G20; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Portfolio strategy (G11) | Overall returns (G12) |
| Investment size (G11) | Returns (Y70) |
| Industry concentration (L69) | Performance (D29) |
| Geographic concentration (R32) | Performance (D29) |
| GP-specific return variation (C59) | Total return variation (G11) |
| Managerial skill (M54) | Investment outcomes (G11) |