In the recently released first quarter of 2013 private equity (PE) /venture capital (VC) benchmarking brief, Pitchbook reports the global average internal rates of return (IRR) for four fund types and all private equity funds (buyout funds, venture capital funds, mezzanine funds, and fund of funds funds). Which specialty area would you guess comes out on top?
Well, in the most recent year for which reliable data are available, fund of funds have the highest IRR, with an IRR value of about 6%. Following fund of funds lead is mezzanine funds at about 4%, after which falls VC funds (3%). All PE funds (2%) and buyout funds (2%) round out the reported groups.
Why would fund of funds and mezzanine be on top? The answer for fund of funds is likely that the group includes mezzanine funds, which bump the IRR for fund of funds up above the other two areas.
But, why would mezzanine be on top? Well, the simple answer is that the group probably benefited from the tighter lending standards imposed on borrowers following the 2008 and 2009 financial crisis. Mezzanine funds were no different than others in the lending industry, with lenders only doing business with higher quality loans.
What’s interesting about the chart is that there has been a decade long decline in the IRRs across pretty much all fund types. The observation has at least two explanations, with neither of them implying that the 10 years shown in Pitchbook’s presentation are trends that are here to stay.
The first explanation is that the trend starts in 2001, a time when things were generally good on an economy-wide basis. The markets, of course, entered bear territory following the bursting of confidence in technology (some might call it a bursting of a bubble, such as Greenspan’s famous irrational exuberance argument; whether it was a bubble or not is an argument for academic economists for another day). As is shown, the general decline lasted until about 2006, at which point all fund types began to see an increase in their respective IRRs. The strengthening of the IRR trend was short-lived, with the 2008 and 2009 financial crisis taking its toll.
The second explanation is that of increasing supply – competition among financial investors – for growing, but limited demand. It’s actually not that demand is limited; it’s just that supply of funds is growing faster than demand for funds, which shifts the deals generally towards the company desiring investment.
Is it correct to say that these two observations are not long-term trends? Probably. The first explanation – the economy’s effect on PE funds’ IRRs – is certainly not a long-term detriment to PE IRRs.
The second issue – that of faster growing supply of investment funding for slower growing demand for the investment dollars – is something industry executives, economists, and others may debate for some time with little agreement. What appears to be clear from the discussions is that all agree that they hope the answer is that it’s not a long-term trend.
In all, IRRs over the past ten years for pretty much all PE fund types have declined. After adjusting for the economy’s effect, one has to wonder how much of the decline is here to stay.
Comments on this entry are closed.