The Cyclicality of Returns for Private Equity Funds

Abstract: This paper aims to empirically test whether European Private Equity investments made at the end of the investment cycle underperform with respect to investments made earlier in the cycle. A theoretical model suggesting the occurrence of such a behavior, due to the structure of the fees paid to the general partners is suggested by Axelsson, Strömberg and Weisbach (2009). Our goal is to test whether this behavior can be found in our data. We have used a unique dataset provided by the European Investment Fund containing deal level data for 294 PE/VC funds and 3,150 investments. Excess returns were measured for each individual investment using the Public Market Equivalent method. We did not find any significant results for time affecting excess returns and could therefore neither prove nor disprove the occurrence of lower returns at the end of the investment cycle. We believe that this result could be partially driven by EIF specific biases. However, we did observe low returns for investments made both at the beginning and at the end of the investment cycle. We found a positive relationship between the size of the management fees and the investments' excess returns. Furthermore, we found that almost half of the funds made their last investment well before the end of the investment period, while still having a large part of their committed capital unutilized.