RESEARCH PAPERS | ALTERNATIVE INVESTMENTS
International Private Equity Activity
DETERMINANTS OF INTERNATIONAL BUYOUT INVESTMENTS
Serdar Aldatmaz, Gregory W. Brown, and Asli Demirgüç-Kunt
2020
Using a comprehensive and proprietary data set on international private equity activity, this paper studies the determinants of buyout investments across 61 countries and 19 industries over 1990-2017. The study finds evidence that macroeconomic conditions, development of stock and credit markets, and the regulatory environment in a country are important drivers of international buyout capital flows. The paper shows that countries with low unemployment, more active stock and credit markets, and better rule of law receive more buyout capital. A difference-in-differences approach is used to explore the regulatory reforms some countries have adopted over the sample period. The findings are that countries receive significantly more buyout capital following investor protection and contract enforcement reforms. The impact of regulatory reform is more pronounced in countries with better corporate governance standards and education. Buyout investment responds to these factors more so than foreign direct investment and gross domestic fixed investment. >more
Private Equity Performance
PRIVATE EQUITY PORTFOLIO COMPANIES: A FIRST LOOK AT BURGISS HOLDINGS DATA
Gregory W. Brown, Robert S. Harris, Wendy Hu, Tim Jenkinson, Steven N. Kaplan, and David T. Robinson
2020
This paper provides a first look at newly available data on the holdings of private equity (PE) funds. Because research has been hampered by the lack of comprehensive, high-quality data on portfolio companies, this new source offers the potential for a wide range of research. Provided by Burgiss, a global provider of data and analytics to investors in PE funds (limited partner investors or LPs), the data are gathered from the financial reports of general partners (GPs) to LPs who are Burgiss clients. The sample covers over 45,000 investments in funds’ portfolio companies (in buyout and venture capital); moreover, the coverage is expected to grow through a phased release process. The paper describes preliminary findings on sample characteristics and offers a high-level view on aspects of performance in hopes of inspiring additional research. >more
Public vs. Private Equity
PUBLIC VERSUS PRIVATE EQUITY
René M. Stulz
2019
The last twenty years or so have seen a sharp decline in public equity. I present a framework that explains the forces that cause the listing propensity of firms to change over time. This framework highlights the benefits and costs of a public listing compared to the benefits and costs of financing with private equity. With this framework, the decline in public equity is explained by the increased supply of funds for private equity and changes in the nature of firms. The increase in the importance of intangible assets makes it costlier for young firms to be public when the alternative is funding through private equity from investors who have specialized knowledge that enables them to better understand the business model of young firms and contribute to the development of that business model in contrast to passive public equity investors. >more
Gender Gap in VC
NETWORKING FRICTIONS IN VENTURE CAPITAL, AND THE GENDER GAP IN ENTREPRENEURSHIP
Sabrina Howell, and Ramana Nanda
2019
Exploiting random variation in the number of venture capitalist (VC) judges assigned to panels at Harvard Business School’s New Venture Competition (NVC) between 2000 and 2015, we find that exposure to more VC judges increases male participants’ chances of founding a VC-backed startup after HBS much more than this exposure increases female participants’ chances. A survey suggests this is in part because male participants more often proactively reach out to VC judges after the NVC. Our results suggest that networking frictions are an important reason men benefit more than women from exposure to VCs. Such frictions can help explain part of the gender gap in entrepreneurship, and also have implications for how to design networking opportunities to facilitate financing of the best (rather than just the best networked) ideas. >more
Green Investments
TALKING ABOUT THE WEATHER: AVAILABILITY, AFFECT AND THE DEMAND FOR GREEN INVESTMENTS
Anders Anderson, and David T. Robinson
2019
We survey investors and establish a link between adverse weather events and beliefs about future climate calamities. By matching the survey to individual registry data, we study how exposure to climate calamities drives people to make “green” choices. These individuals are more likely to say they recycle more than their neighbors, are willing to pay extra for environmentally friendly products, think green investments outperform, and are willing to pay higher fees for green mutual funds. They also trade their retirement portfolios into investments that tout environmental sustainability. >more
FinTech
HOW DO BANKS INTERACT WITH FINTECH STARTUPS?
Lars Hornuf, Milan Klus, Todor Lohwasser, and Armin Schwienbacher
2020
The increasing pervasiveness of technology-driven firms that offer banking services has led to a growing pressure on traditional banks to modernize their core business activities. Many banks tackle the challenges of digitalization by cooperating with startup firms that offer technology-driven financial services (fintechs). In this paper, we examine which banks typically collaborate with fintechs, how intensely they do so, and which form of alliance they prefer. Using hand-collected data covering the largest banks from Canada, France, Germany, and the United Kingdom, we provide detailed evidence on the different forms of alliances occurring in practice. We show that banks are significantly more likely to form alliances with fintechs when they pursue a well-defined digital strategy and/or employ a chief digital officer. Moreover, in line with incomplete contract theory, we find that banks more frequently invest in small fintechs but often build product-related collaborations with larger fintechs. >more
Crowdlending
RISKS AND RETURNS IN CROWDLENDING
Saman Adhami, Gianfranco Gianfrate, and Sofia Johan
2019
Crowdlending has emerged in recent years as an innovative way to finance new ventures and small companies. However, digitalized funding is a new technology itself; therefore, it is prone to mispricing and inefficiencies. We investigate whether peer-to-peer crowdlending to businesses provides investors with returns consistent with the level of risk borne. By studying over 3000 loans mediated on 68 European platforms we show that the returns are inversely related to loans’ riskiness, suggesting that, on average, crowdfunded loans are mispriced. Our results have important implications for the debate about the role of regulation in FinTech. >more
VC Performance
THE PERSISTENT EFFECT OF INITIAL SUCCESS: EVIDENCE FROM VENTURE CAPITAL
Ramana Nanda, Sampsa Samila, and Olav Sorenson
2019
We use investment-level data to study performance persistence in venture capital (VC). Consistent with prior studies, we find that each additional IPO among a VC firm's first ten investments predicts as much as an 8% higher IPO rate on its subsequent investments, though this effect erodes with time. In exploring its sources, we document several additional facts: successful outcomes stem in large part from investing in the right places at the right times; VC firms do not persist in their ability to choose the right places and times to invest; but early success does lead to investing in later rounds and in larger syndicates. This pattern of results seems most consistent with the idea that initial success improves access to deal flow. That preferential access raises the quality of subsequent investments, perpetuating performance differences in initial investments. >more
Hedge Funds
UNOBSERVED PERFORMANCE OF HEDGE FUNDS
Vikas Agarwal, Stefan Ruenzi, and Florian Weigert
2019
We investigate hedge funds’ unobserved performance (UP), measured as the risk-adjusted return difference between a fund firm’s reported return and the hypothetical portfolio return derived from its disclosed long equity holdings. We find that high UP is (i) positively associated with measures of managerial incentives, discretion, and skill, and (ii) driven by a fund firm’s frequent trading in equity positions, derivatives usage, short selling, and confidential holdings. Fund firms with high UP outperform fund firms with low UP by more than 6% p.a. after accounting for typical hedge fund risk factors and fund characteristics. >more
Climate Finance
INSTITUTIONAL INVESTORS’ VIEWS AND PREFERENCES ON CLIMATE RISK DISCLOSURE
Emirhan Ilhan, Philipp Krueger, Zacharias Sautner, and Laura T. Starks
2019
We survey institutional investors on firms’ climate risk disclosures. Many investors believe climate risk reporting to be as important as traditional financial reporting and that it should be mandatory and more standardized. However, they also view current quantitative and qualitative disclosure on climate risks as being insufficient and imprecise. The belief that current climate-related disclosure is deficient derives more from investors that believe climate risks are underpriced in equity markets. We complement the survey analysis with archival data showing that greater institutional ownership is associated with a higher propensity of firms to voluntarily disclose their carbon emissions. >more
PE Performance
WHOM TO FOLLOW: INDIVIDUAL MANAGER PERFORMANCE AND PERSISTENCE IN PRIVATE EQUITY INVESTMENTS
Reiner Braun, Nils Dorau, Tim Jenkinson, and Daniel Urban
2019
Using a sample of 3,977 individual buyout managers with more than 10,330 deal involvements in 5,030 unique buyout transactions we investigate individual manager performance and its persistence. We find evidence for deal-level gross PME performance persistence at this level of analysis. In explaining the cross-section of deal returns, the individual is around four times more important than the PE organization. Interestingly, none of the typical human capital variables (age, gender, MBA, PE tenure) has explanatory power in the cross-section of deal returns. >more
Private Equity Returns
RISK ADJUSTMENT IN PRIVATE EQUITY RETURNS
Arthur G. Korteweg
2018
This article reviews empirical methods to assess risk and return in private equity. I discuss data and econometric issues for deal-level, fund-level, and publicly traded partnerships data. Risk-adjusted return estimates vary substantially by method, time period, and data source. The weight of evidence suggests that relative to a similarly risky investment in the stock market, the average venture capital (VC) fund earned positive risk-adjusted returns before the turn of the millennium, but net-of-fee returns have been zero or even negative since. Average leveraged buyout (BO) investments have generally earned positive risk-adjusted returns both before and after fees, relative to a levered stock portfolio. I also consider additional risk factors proposed in the literature. VC looks like a small-growth investment, while BO loads mostly on value. Liquidity and idiosyncratic risks are also discussed. >more
Hedge Funds
MAN VS. MACHINE: COMPARING DISCRETIONARY AND SYSTEMATIC HEDGE FUND PERFORMANCE
Campbell R. Harvey, Sandy Rattray, Andrew Sinclair, and Otto Van Hemert
2019
We analyse and contrast the performance of discretionary and systematic hedge funds. Systematic funds use strategies that are rules-based, with little or no daily intervention by humans. In our experience, some large allocators shy away from systematic hedge funds altogether. A possible explanation for this is what the psychology literature calls “algorithm aversion”. However, we find no empirical basis for such an aversion. For the period 1996-2014, systematic and discretionary manager performance is similar, after adjusting for volatility and factor exposures, i.e., in terms of their appraisal ratio. It is sometimes claimed that systematic funds’ returns have a greater exposure to well-known risk factors. We find, however, that for discretionary funds (in the aggregate) more of the average return and the volatility of returns can be explained by risk factors. >more
Co-Investments
ADVERSE SELECTION AND THE PERFORMANCE OF PRIVATE EQUITY CO-INVESTMENTS
Reiner Braun, Tim Jenkinson, and Christoph Schemmerl
2018
Investors increasingly look for private equity managers to provide opportunities for co-investing outside the fund structure, thereby saving fees and carried interest payments. In this paper we use a large sample of buyout and venture capital co-investments to test how such deals compare with the remaining fund investments. In contrast to Fang, Ivashina and Lerner (2015) we find no evidence of adverse selection. Gross return distributions of co-investments and other deals are similar. Co-investments generally have lower costs to investors. We simulate net returns to investors and demonstrate how reasonably sized portfolios of co-investments significantly out-perform fund returns. >more
VC Contracts
VENTURE CAPITAL CONTRACTS
Michael Ewens, Alexander S. Gorbenko, and Arthur G. Korteweg
2019
We estimate the impact of venture capital (VC) contract terms on startup outcomes and the split of value between the entrepreneur and investor, accounting for endogenous selection via a novel dynamic search and matching model. The estimation uses a new, large data set of first financing rounds of startup companies. Consistent with efficient contracting theories, there is an optimal equity split between agents that maximizes the probability of success. However, VCs use their bargaining power to receive more investor-friendly terms compared to the contract that maximizes startup values. Better VCs still benefit the startup and the entrepreneur, due to their positive value creation. Counterfactual exercises show that eliminating certain contract terms benefits entrepreneurs and enables low-quality entrepreneurs to finance their startups more quickly, increasing the number of deals in the market. Lowering search frictions shifts the bargaining power to VCs and benefits them at the expense of entrepreneurs. The results show that selection of agents into deals is a first-order factor to take into account in studies of contracting. >more
Placement Agents
INTERMEDIATION IN PRIVATE EQUITY: THE ROLE OF PLACEMENT AGENTS
Matthew D. Cain, Stephen B. McKeon, and Steven Davidoff Solomon
2017
Intermediation in private equity involves illiquid investments, professional investors, and high information asymmetry. We use this unique setting to empirically evaluate theoretical predictions regarding intermediation. Placement agent usage has become nearly ubiquitous, but agents are associated with significantly lower abnormal returns in the cross-section. However, returns are higher for funds employing a top-tier agent, and for first-time funds employing an agent. We also find evidence that agents may mitigate investment risk. Our results provide support for both the certification and influence peddling roles of intermediaries discussed in theoretical literature, suggesting heterogeneous motives for intermediation in the private equity industry. >more
Endowments
HOW DO FINANCIAL EXPERTISE AND NETWORKS AFFECT INVESTING? EVIDENCE FROM THE GOVERNANCE OF UNIVERSITY ENDOWMENTS
Matteo Binfarè, Gregory W. Brown, Robert S. Harris, and Christian T. Lundblad
2019
We examine the link between endowment investment performance and the expertise of university board members. Harnessing detailed information on 11,019 members for 579 universities, we find that expertise in alternatives and larger professional networks are associated with higher allocations to alternatives and better investment results. Expertise and networks appear particularly important in private equity and venture capital, which are difficult to analyze and manage. The improved investment performance arises because endowments capture higher returns that can accompany alternative assets, select or have access to high performing managers, and minimize fees by using direct funds rather than funds of funds. While identification of a causal effect of expertise and networks on allocations and performances is challenging, we conduct a novel survey of 132 endowment managers and boards (collectively over 60% of endowment assets), and confirm that board expertise is central in facilitating alternative asset investments. >more
Private Equity and Taxes
PRIVATE EQUITY AND TAXES
Marcel Olbert, and Peter Severin
2018
We study companies' tax avoidance behavior after being acquired in a private equity transaction. Using firm-level data from Europe, we analyze target firms' tax payments after the acquisition compared to a carefully selected control group in a matched-sample difference-in-differences setting. We find that target companies' effective tax rate decreases by 16.14% relative to the unconditional mean. This finding is in line with the hypothesis that private equity investors create shareholder value by extracting money from the government. While our evidence suggests that target firms engage more heavily in profit shifting, we do not find direct evidence in support of a tax-motivated leverage channel. We further show that those target firms that become more tax efficient experience significantly lower asset and employment growth than target firms with no or moderate tax savings after the buyout. This finding indicates that tax savings are not used to finance investment but are directly transferred to shareholders. >more
Carried Interest
MODIFYING THE CARRIED INTEREST TO DO WHAT IT IS SAID TO DO
Ludovic Phalippou
2019
The carried interest received by private equity fund managers (General Partners; GPs) generates some controversies. The three most debated claims are that carried interest i) aligns incentives, ii) should be treated as a capital gain for tax purposes, and iii) should not be reported as a fee charged to investors. The existence of two key principal-agent relationships within the private equity model might be at the root of these controversies. One relationship links the GP as principal and portfolio company management team as agent. In this first contract, the three claims hold true. The other relationship links fund investors (Limited Partners; LPs) as principal with the GP as agent. I show that modifying that second contract by introducing a first-loss feature and reducing significantly the catch-up rate makes the two contracts equivalent. Hence, the benefits of the limited partnership structure can co-exist in a setting where the three claims about carried interest hold true. >more
Corporate Venture Capital
THE LIFE CYCLE OF CORPORATE VENTURE CAPITAL
Song Ma
2019
This paper investigates why industrial firms conduct Corporate Venture Capital (CVC) investment in entrepreneurial companies. I test alternative views on CVC by exploiting the entry, investment, and termination decisions of CVC divisions. CVC entry concentrates in firms that experience deteriorations of internal innovation. At the investment stage, CVCs select startups with a similar technological focus but that have a non-overlapping knowledge base, and they integrate technologies generated from these ventures that create strategic value. CVCs are terminated when parent firms' innovation recovers. Overall, the strategic desire to fix innovation weaknesses after adverse shocks motivates firms to adopt CVCs. >more
Bitcoin
FROM MINING TO MARKETS: THE EVOLUTION OF BITCOIN TRANSACTION FEES
David Easley, Maureen O'Hara, and Soumya Basu
2019
We investigate the role that transaction fees play in the Bitcoin blockchain’s evolution from a mining-based structure to a market-based ecology. We develop a game-theoretic model to explain the factors leading to the emergence of transactions fees, as well as to explain the strategic behavior of miners and users. Our model also highlights the role played by mining rewards and by volume, and examines how microstructure features such as exogenous structural constraints influence the dynamics and stability of the Bitcoin blockchain. We provide empirical evidence on the predictions of our model and discuss implications for Bitcoin’s evolution. >more
Investment Skill
MEASURING INSTITUTIONAL INVESTORS’ SKILL AT MAKING PRIVATE EQUITY INVESTMENTS
Daniel Cavagnaro, Berk A. Sensoy, Yingdi Wang, and Michael S. Weisbach
2018
Using a large sample of institutional investors’ investments in private equity funds raised between 1991 and 2011, we estimate the extent to which investors’ skill affects their returns. Bootstrap analyses show that the variance of actual performance is higher than would be expected by chance, suggesting that some investors consistently outperform. Extending the Bayesian approach of Korteweg and Sorensen (2017), we estimate that a one standard deviation increase in skill leads to an increase in annual returns of between one and two percentage points. These results are stronger in the earlier part of the sample period and for venture funds. >more
Alpha
BUFFETT'S ALPHA
Andrea Frazzini, David Kabiller, and Lasse Heje Pedersen
2018
Berkshire Hathaway has realized a Sharpe ratio of 0.79 with significant alpha to traditional risk factors. However, the alpha becomes insignificant when controlling for exposures to Betting-Against-Beta and Quality-Minus-Junk factors. Further, we estimate that Buffett’s leverage is about 1.7-to-1 on average. Therefore, Buffett’s returns appear to be neither luck nor magic, but, rather, reward for leveraging cheap, safe, quality stocks. Decomposing Berkshires’ portfolio into ownership in publicly traded stocks versus wholly-owned private companies, we find that the former performs the best, suggesting that Buffett’s returns are more due to stock selection than to his effect on management. >more
VC Syndication
VENTURE CAPITAL COMMUNITIES
Amit Bubna, Sanjiv Ranjan Das, and Nagpurnanand Prabhala
2018
While VCs can choose from thousands of potential syndicate partners, many prefer to co-syndicate with partners drawn from small groups of preferred partners, whom we term "VC communities." Using computational methods from the physical sciences, we identify communities from three decades of syndication data and characterize their number, size, composition, and economic activities. Communities comprise VCs similar in age, connectedness, and functional style and undifferentiated spatial locations. Machine learning tools classify communities into three groups roughly ordered by VC age and reach. Community VC financing is associated with faster maturation and greater innovation especially for early-stage firms without innovation histories. >more
Business Angels
THE PERFORMANCE OF ANGEL-BACKED COMPANIES
Stefano Bonini, Vincenzo Capizzi, and Paola Zocchi
2018
We provide empirical evidence of the post-investment performance and survivorship profile of angel-backed companies, filling a long-standing gap within the entrepreneurial finance literature. Using a unique database of 111 angel-backed companies that received angel investments between 2008 and 2012 and at least 3 years of post-investment financial data, we develop an innovative performance metric and show that the performance and the probability of survival of investee companies are positively affected by the presence of angel syndicates and the hands-on involvement of business angels, while they are negatively related to the intensity of angel monitoring and the structure of equity provision. Our results are robust to several endogeneity tests and provide insights on the multifaceted contributions of angel investors to the performance and survival of new ventures. >more
Buyouts and Innovation Activity
PUBLIC-TO-PRIVATE BUYOUTS AND INNOVATION
Douglas J. Cumming, Rejo Peter, and Monika Tarsalewska
2018
We study the effect of public-to-private buyout transactions on investments in innovation using an international sample from thirty-six countries over the 1997-2017 period. We use patent counts and citations to proxy for the quantity, quality, and economic importance of innovation. Our results are based on time analysis and matched sample regressions. The data indicate that buyouts are associated with a significant reduction in patents and patent citations, including a reduction of radical (i.e., more scientific) patents. When we split the sample into institutional and management buyouts, the negative effect of buyouts is confirmed only for institutional buyouts, suggesting that highly leveraged transactions prevent target firms from adopting long-term investments. This finding is confirmed by reductions in innovator employment and innovation efficiency subsequent to going private. Moreover, the data indicate that the negative effect is mostly prevalent for transactions where the cost of the deal’s debt financing is higher than the post-buyout cost of the debt. For deals financed only with private equity, this effect is aggravated in the post-2006 period, suggesting that the nature of deals has worsened innovation over time. We rule out alternative explanations for these findings, including but not limited to outliers, truncation bias, and endogeneity. >more
Secondary Market for Private Equity Funds
PRIVATE EQUITY INDICES BASED ON SECONDARY MARKET TRANSACTIONS
Brian H. Boyer, Taylor Nadauld, Keith Vorkink, and Michael S. Weisbach
2018
Measuring the performance of private equity investments (buyout and venture) has historically only been possible over long horizons because the IRR on a fund is only observable following the fund’s final distribution. We propose a new approach to evaluating performance using actual prices paid for limited partner shares of funds in secondary markets. We construct indices of buyout and venture capital performance using a proprietary database of secondary market prices between 2006 and 2017. These transaction-based indices exhibit significantly higher betas and volatilities, and lower alphas than NAV-based indices built from Preqin and obtained from Burgiss. There are a number of potential uses for these indices. In particular, they provide a way to track the returns of the buyout and venture capital sectors on a quarter-to-quarter basis and to value illiquid stakes in funds. >more
Initial Coin Offering
INITIAL COIN OFFERINGS (ICOS) TO FINANCE NEW VENTURES
Christian Fisch
2018
In an initial coin offering (ICO), new ventures raise capital by selling tokens to a crowd of investors. Often, this token is a cryptocurrency, a digital medium of value exchange based on the distributed ledger technology. Both the number of ICOs and the amount of capital raised have exploded since 2017. Despite attracting significant attention from ventures, investors, and policy makers, little is known about the dynamics of ICOs. This initial study therefore assesses the determinants of the amount raised in 423 ICOs. Drawing on signaling theory, the study explores the role of signaling ventures' technological capabilities in ICOs. The results show that technical white papers and high-quality source codes increase the amount raised, while patents are not associated with increased amounts of funding. Exploring further determinants of the amount raised, the results indicate that some of the underlying mechanisms in ICOs resemble those found in prior research into entrepreneurial finance, while others are unique to the ICO context. >more
Alternative Investment Vehicles
INVESTING OUTSIDE THE BOX: EVIDENCE FROM ALTERNATIVE VEHICLES IN PRIVATE CAPITAL
Josh Lerner, Jason Mao, Antoinette Schoar, and Nan R. Zhang
2018
This paper undertakes a comprehensive analysis of alternative investment vehicles in private equity, using unexplored custodial data about 112 limited partners over four decades. We differentiate between alternative vehicles that are GP-directed versus those where the LP has some discretion. Of the roughly 5500 distinct investments made by the LPs in our sample, 32% of investments (17% of capital commitments) were in such alternative vehicles; the allocation increased by more than 10 percentage points over the last decade. Alternative vehicles were far more likely to be offered by larger and North America-based buyout funds. The average performance of these alternative vehicles lagged that of the GPs’ corresponding main funds. The best LP performance was among endowments, private pensions, and insurers. Finally, LPs with better past performance invested in alternative vehicles with better performance, even after conditioning on the GPs’ past records. This result suggests that bargaining between GPs and LPs leads to gradation in investment performance based on the parties’ outside options. >more
Angel Investing
ARE EARLY STAGE INVESTORS BIASED AGAINST WOMEN?
Michael Ewens, and Richard Townsend
2018
We examine whether male investors are biased against female entrepreneurs using a proprietary dataset from AngelList that allows us to observe private interactions between investors and fundraising startups. We find that male investors express less interest in female-led startups compared to observably similar male-led startups. Female investors do not exhibit the same behavior, despite appearing to have similar investment objectives; female investors agree with male investors when comparing founders who are all men, or all women. Finally, the male-led startups that male investors express interest in do not outperform the female-led startups they express interest in—they underperform. Overall, the evidence is consistent with some form of gender bias. >more
Private Equity Commitments
CAN INVESTORS TIME THEIR EXPOSURE TO PRIVATE EQUITY?
Gregory W. Brown, Robert S. Harris, Wendy Hu, Tim Jenkinson, Steven N. Kaplan, and David T. Robinson
2018
Private equity performance, both for buyouts and venture capital, has been highly cyclical: periods of high fundraising have been followed by periods of low absolute performance. Despite this seemingly predictable variation, we find modest gains, at best, to pursuing more realistic, investable strategies that time capital commitments to private equity. This occurs because investors can only time their commitments to funds; they cannot time when their commitments are called or when their investments are exited. There is a high degree of time-series correlation in net cash flows even across commitment strategies that allocate capital in a very different manner over time. >more
Hedge Fund Returns
PUBLIC HEDGE FUNDS
Lin Sun, and Melvyn Teo
2017
Hedge funds managed by listed firms significantly underperform funds managed by unlisted firms. The underperformance is more severe for funds with low manager deltas, poor governance, and no manager co-investment, or managed by firms whose prices are sensitive to earnings news. Notwithstanding the underperformance, listed asset management firms raise more capital, by growing existing funds and launching new funds post listing, and harvest greater fee revenues than do comparable unlisted firms. The results are consistent with the view that, for asset management firms, going public weakens the alignment between ownership, control, and investment capital, thereby engendering conflicts of interest. >more
Investment Decisions
LOW INTEREST RATES AND RISK TAKING: EVIDENCE FROM INDIVIDUAL INVESTMENT DECISIONS
Chen Lian, Yueran Ma, and Carmen Wang
2018
How do low interest rates affect investor behavior? We demonstrate that individuals “reach for yield,” that is, have a greater appetite for risk taking when interest rates are low. Using randomized investment experiments holding fixed risk premia and risks, we show low interest rates lead to significantly higher allocations to risky assets among diverse populations. The behavior is not easily explained by conventional portfolio choice theory or institutional frictions. We then propose and provide evidence for mechanisms related to investor psychology, including reference dependence and salience. We also present results using observational data on household investment decisions. >more
Hedge Funds
SENSATION SEEKING AND HEDGE FUNDS
Stephen Brown, Yan Lu, Sugata Ray, and Melvyn Teo
2018
We show that motivated by sensation seeking, hedge fund managers who own powerful sports cars take on more investment risk but do not deliver higher returns, resulting in lower Sharpe ratios, information ratios, and alphas. Moreover, sensation-seeking managers trade more frequently, actively and unconventionally, and prefer lottery-like stocks. We show further that some investors are themselves susceptible to sensation seeking and that sensation-seeking investors fuel the demand for sensation-seeking managers. While investors perceive sensation seekers to be less competent, they do not fully appreciate the superior investment skills of sensation-avoiding fund managers. >more
Partnership Economics
PAY NOW OR PAY LATER? THE ECONOMICS WITHIN THE PRIVATE EQUITY PARTNERSHIP
Victoria Ivashina, and Josh Lerner
2018
The economics of partnerships have been of enduring interest to economists, yet it is not clear what profit sharing within a private partnership should look like. We examine over seven hundred private equity partnerships, and show that the allocation of fund economics to individual partners varies drastically even among the most senior partners and appears divorced from past success as an investor, being instead related to status as a founder. A smaller share of carried interest and ownership - and inequality in fund economics more generally - is associated with departures of senior partners, which, in turn, is negatively related to the funds’ ability to raise additional capital. >more
Hedge Fund Activism
HEDGE FUND ACTIVISM, FIRM VALUATION AND STOCK RETURNS
Martijn Cremers, Erasmo Giambona, Simone M. Sepe, and Ye Wang
2018
This paper studies the association between hedge fund activism and firm value, using matching procedures to incorporate the nonrandom selection of firms targeted by activist hedge funds. We find that targeted firms improve less in value (Q) subsequent to activism starts than ex-ante similarly poorly performing control firms that are not subject to activist campaigns. Further, long-term abnormal stock returns of both target and control firms are similarly positive and significant. However, activist hedge funds have strong stock selection skills as well as strong trading skills that allow them to outperform. >more
Start-up Formation
BUSINESS CYCLES AND START-UPS ACROSS INDUSTRIES: AN EMPIRICAL ANALYSIS OF GERMAN REGIONS
Alexander Konon, Michael Fritsch, and Alexander Kritikos
2018
We analyze whether start-up rates in different industries systematically change with business cycle variables. Using a unique data set at the industry level, we mostly find correlations that are consistent with counter-cyclical influences of the business cycle on entries in both innovative and non-innovative industries. Entries into the largescale industries, including the innovative part of manufacturing, are only influenced by changes in the cyclical component of unemployment, while entries into small-scale industries, like knowledge intensive services, are mostly influenced by changes in the cyclical component of GDP. Thus, our analysis suggests that favorable conditions in terms of high GDP might not be germane for start-ups. Given that both innovative and non-innovative businesses react counter-cyclically in ‘regular’ recessions, business formation may have a stabilizing effect on the economy. >more
Hedge Fund Activism
HOSTILE RESISTANCE TO HEDGE FUND ACTIVISM
Nicole M. Boyson, and Pegaret Pichler
2018
When facing hedge fund activists, target firms often fight back. Targets with agency problems and those confronting the threat of investor coordination frequently engage in hostile resistance by implementing governance changes associated with managerial entrenchment. The market negatively responds to hostile resistance, and unless hedge funds counter-resist, these campaigns have worse operating performance, faster activist exit, and fewer mergers than do campaigns without hostile target resistance. By contrast, when hedge funds counter-resist with proxy fights, lawsuits, or unsolicited tender offers, the impact of hostile target resistance is reversed, and these campaigns have similar outcomes to campaigns without hostile target resistance. >more
Private Equity Returns
ESTIMATING PRIVATE EQUITY RETURNS FROM LIMITED PARTNER CASH FLOWS
Andrew Ang, Bingxu Chen, William N. Goetzmann, and Ludovic Phalippou
2017
We introduce a methodology to estimate the historical time-series of returns to investment in private equity funds. The approach requires only an unbalanced panel of cash contributions and distributions accruing to limited partners, and is robust to sparse data. We decompose private equity returns into a component due to traded factors and a time-varying private equity premium. We find strong cyclicality in private equity returns that differs according to fund type. The time-series estimates allow us to directly test theories about private equity cyclicality, and we find evidence that capital market segmentation helps to determine private equity returns. >more
Fund of Funds
FINANCIAL INTERMEDIATION IN PRIVATE EQUITY: HOW WELL DO FUNDS OF FUNDS PERFORM?
Robert S. Harris, Tim Jenkinson, Steven N. Kaplan, and Rüdiger Stucke
2017
This paper focuses on funds of funds (FOFs) as a form of financial intermediation in private equity (both buyout and venture capital). After accounting for fees, FOFs provide returns equal to or above public market indices for both buyout and venture capital. While FOFs focusing on buyouts outperform public markets, they underperform direct fund investment strategies in buyout. In contrast, the average performance of FOFs in venture capital is on a par with results from direct venture fund investing. This suggests that FOFs in venture capital (but not in buyouts) are able to identify and access superior performing funds. >more
Hedge Fund Investment Behavior
DO HEDGE FUNDS EXPLOIT RARE DISASTER CONCERNS?
George Gao, Pengjie Gao, and Zhaogang Song
2017
We find hedge funds that have higher return covariation with a disaster concern index, which we construct using out-of-the-money puts on sector indices, earn significantly higher returns. These funds have better skills in exploiting the market's ex ante rare disaster concerns (SED) that are not associated with disaster risk. In particular, high-SED funds on average outperform low-SED funds by 0.96% per month, but have less exposure to disaster risk. They continue to deliver superior future performance when SED is estimated using the disaster concern index purged of disaster risk premiums, and have leverage-managing and extreme-market-timing abilities. >more
Hedge Fund Flows
ALPHA OR BETA IN THE EYE OF THE BEHOLDER: WHAT DRIVES HEDGE FUND FLOWS?
Vikas Agarwal, T. Clifton Green, and Honglin Ren
2017
CAPM alpha explains hedge fund flows better than alphas from more sophisticated models. This suggests that investors pool together sophisticated model alpha with returns from exposures to traditional (except for the market) and exotic risks. We decompose performance into traditional and exotic risk components and find that while investors chase both components, they place greater relative emphasis on returns associated with exotic risk exposures that can only be obtained through hedge funds. However, we find little evidence of persistence in performance from traditional or exotic risks, which cautions against investors’ practice of seeking out risk exposures following periods of recent success. >more
Private Equity & Real Economy
IS PRIVATE EQUITY GOOD FOR CONSUMERS?
Cesare Fracassi, Alessandro Previtero, and Albert Sheen
2017
We investigate the effects of private equity on consumers using detailed price and sales data for an extensive number of consumer products. We find that firms acquired by private equity raise prices marginally---less than 1%---on existing products relative to matched control firms. Overall industry prices rise after buyouts, but again the price increase is on average very modest. More notably, target firms significantly increase sales due to more product additions and greater availability within and across cities. These results are stronger for private firm targets, suggesting that private equity could ease financial constraints and provide the expertise to manage growth. Contrary to the common view that private equity leads to substantial price increases, this evidence suggests that consumers could benefit from private equity deals through an increase in product variety. >more
