Whether you’re a seasoned professional or a relative newbie to private equity (PE) investing, you may have wondered how PE firms are rated. Well, it’s a tricky business, and getting reliable data on performance isn’t always easy to come by.
Private equity firms are major players on the financial scene. One of their principal strategies is the leveraged buyout (LBO). Indeed, it was an LBO by the PE firm KKR & Co that inspired the book and later the movie ‘Barbarians at the Gate’.
If you’re shopping for a top private equity firm, there are a few metrics you can use to help you make your decision. For example, you can examine the volume of funds invested, historical financial performance, and the longevity of the firm.
Let’s take a deeper look.
The Basics of Private Equity
How Does Private Equity Work?
Private equity firms bundle investor cash and invest it in businesses over the long term. A PE outfit will likely specialize in certain market sectors and target specific types of companies. It will frequently get involved in business operations, looking to improve performance and achieve capital growth.
Investment Strategies: Leveraged Buyouts and Venture Capital
In a leveraged buyout, a PE sponsor will acquire all or a controlling interest in a target firm. Often, it will borrow a large amount of cash (leverage), secured by the target’s assets. The use of debt increases the returns on equity (ROE) and the internal rate of return (IRR), assuming the company performs well.
In contrast, a PE firm offering VC funding will use investor cash to acquire capital in a new or developing business to create capital growth.
Long-Term Investment Horizons
In contrast to hedge funds that invest over the shorter term and don’t involve themselves with company operations, private equity is a long-term, hands-on investment.
How Can You Rank Private Equity Firms?
Evaluate Their Assets Under Management (AUM)
Because private equity firms are constantly churning funds, one way to measure success is to look at the amount of capital raised. Another way is to calculate the current market value of all the investments made on behalf of that firm’s clients, known as Assets Under Management (AUM).
Look at Their Successes in Returning Gains to Investors
Private equity has a formidable reputation for achieving dramatic returns. This is typically attributed to the fiscal advantages of using debt finance, a laser-like focus on profit and cash management, and relatively light regulation.
The Age of the Firm
While the origins of private equity date back to the ‘40s, there have been four principal PE eras since then: before the LBO boom, from the end of the 80s to when the dot com bubble burst in 2000, up until the financial crash of 2008, and from then until now. You can add on top of that a series of boom-and-bust cycles. Because of all this fluctuation, a firm’s longevity and ability to withstand market knocks is a relatively solid metric to judge them by.
Based on the metrics laid out here, we can examine some of the very best PE firms and how they emerge from the data very successfully. In turn, these are KKR, the Blackstone Group Inc. (Blackstone), CVC Capital Partners (CVC), and the Carlyle Group Inc (Carlyle). Let’s see how these top firms fare on various criteria.
Evaluating Private Equity Firms Based on Return to Investors
It’s tricky to evaluate the private equity performance of a firm, primarily because a firm may well have more than fifty different funds, all with different strategies and different teams managing them. An investor should be focusing on the performance of a recent fund in the area that they want to invest in. For instance, if you wanted to invest in KKR’s new fund for Southeast Asian tech companies, the performance of their funds for American infrastructure isn’t relevant and would only confuse your decision-making process. The team handling that fund will be completely different and they’ll be up against all of the contextual specificities that come from working in a market on the other side of the world.
Here is one expert’s take on the cumulative net IRR returns of some funds from four well-known firms as of June 2023 [3]:
Blackstone Capital Partners VII: 16.8%
CVC Capital Partners VI: 17.1%
Carlyle Partners V: 12.9%
KKR Asian Fund L.P: 13.6%
Considering Fund Size and Age in Ranking Private Equity Firms
Assessing a Firm’s Age and Its Impact on Success
KKR was a pioneer of the LBO, and prominent transactions include RJR Nabisco and TXU. The firm was founded in 1976, is headquartered in New York, and has offices across 16 countries.
Blackstone also has its HQ in the Big Apple and was founded just before the LBO heyday, in 1985. It too has numerous global offices. Portfolio companies include Refinitiv, Ancestry, and Bumble.
CVC was born in 1981. It’s headquartered in Luxembourg, with its main office in London. Key companies include Breitling, Sunrise, and Continental Foods.
Finally, Carlyle started in 1987 and is based out of Washington, DC. It has a presence on four continents. Its stable includes Jagex, iRobot, and Accolade Wines.
Examining the Size of the Fund as a Metric
Here is the AUM of our four firms as of December 2023 [4]:
KKR: $479 billion
Blackstone: $941 billion
CVC: $127 billion
Carlyle: $326 billion
What Other Metrics Can You Use to Rank Private Equity Firms?
Beyond age, size, and returns, what other methods can you use to measure the performance of private equity firms?
With the IRR, we measure the “speed” of return, where quicker is better. However, this method overlooks an investment’s other qualities such as general return and market factors. Take for example, a $25,000 investment in a fund (Fund X), and say that Fund X will offer you $15,000 per annum over three years. Now, imagine that the same $25,000 investment in a second fund (Fund Y) will generate $100,000 – but only after five years. If we use IRR, Fund X is better performing but, as you can see, this isn’t the whole story.
Alternatively, we can use Modified IRR (MIRR), which overcomes certain shortcomings of the IRR by assuming that cash issued to PE partners is reinvested at more realistic rates. It also accounts for the cost of capital and thereby gives a better picture of PE performance.
Another method is the Multiple of Invested Capital (MOIC). This method ignores time and market movements and simply evaluates how much cash the investment has generated. Judging by this method, Fund Y is the better fund. However, it doesn’t consider the time value of money.
You can also look closely at how a PE firm’s returns mirror the quoted stock market over a similar period (Public Market Equivalent, or PME). This is a useful method as it also considers the state of the market and the economy in general.
While these are the principal metrics for evaluating private equity performance, others include Cash-on-Cash return, Total Value to Paid-in Capital (TVPI), Distributed to Paid-in Capital (DPI), and Gross Portfolio Yield (GPY).
Finally, let’s look at evaluating funds from our firms using the MOIC method. The formula for MOIC can be expressed as:
MOIC = Realized Value + Unrealized Value / Initial Investment
Here are the MOIC for the four funds we looked at when reviewing IRR: Blackstone Capital Partners VII MOIC over the period measured was 1.7x., CVC Capital Partners VI rated 2.0x, Carlyle Partners V rated 1.7x, and KKR Asian Fund L.P comes in at 1.7x as well.
Challenges in Assessing Confidential Data
If you’re an LP looking to invest, it’s natural that you would want to know all of the data available that pertains to your investment. But there are potentially some obstacles to this that you ought to be aware of.
Funds’ Return Data Is Confidential
Since it’s up to each PE firm to come up with numbers, assessing PE returns versus the stock market is more difficult. Portfolio companies aren’t required to issue public reports, and returns aren’t measured until exit.
What Other Metrics Are Available If Confidentiality Is a Barrier?
Aside from the metrics we’re talking about, context is all. You can’t understand a fund’s performance unless you know the state of the market. That’s why many firms specialize, requiring general partners to deep dive into narrow areas of expertise. By becoming an expert yourself, you can use popular metrics alongside industry context to evaluate your investment.
Risks and Rewards in the Private Equity Industry
Each type of investment has different risks and rewards associated with it. And since investment periods are long (generally 10 years and over), you can offset your risk while you’re waiting to get your hands on returns. One downside of PE is illiquidity – unlike publicly traded shares, you can’t swap your shares for cash overnight. However, the downside of quoted shares is that they are highly volatile.
The Role of Metrics in Identifying Successful Private Equity Firms
Harvard Business School professor Randolph Cohen has commented on the tricky nature of investing and the importance of metrics. As he says, it’s difficult to pick a fund without having a ‘systematic way of forming an opinion of which funds will do well in the future, or at least knowing which funds had good performance in the past’. In summary, it ‘turns out that performance evaluation is actually quite tricky’.
The Importance of Balancing Different Metrics for a Comprehensive Evaluation
Using a basket of metrics can better help you measure a firm’s success, its ability to attract funders, and its strategies for investment. By employing these metrics alongside your understanding of the market, you can assess the attractiveness and potential for growth of private equity investments.
Conclusion
If you’re thinking of participating in an investment fund, it’s up to you to make sure the General Partners have the expertise to use your money wisely.
We recommend using the metrics discussed in this article to forge your own opinion.
In any case, there is a reason why firms like The Blackstone Group Inc., KKR & Co. Inc., CVC Capital Partners, and the Carlyle Group Inc. are all household names: they all run funds that put their firms towards the top of the tree when measured on the criteria we’ve discussed here.
Evaluating to a point of certainty will always be difficult due to the variety of funds these firms operate, the necessary balancing of your priorities with the firms’ strengths, and those confidential metrics that muddy the waters too.
But as the economy and the private equity market continue to evolve, metrics are an essential way to ensure firms stay accountable and generate long-term returns for their investors, and by those metrics, the companies we’ve discussed all have strong claims to being one of the very top firms.
If you’d like to understand metrics in more depth and become a private equity investor or an expert in the private equity market, check out Roundtable to find out more.
References
[1] https://en.wikipedia.org/wiki/Private_equity_firm
[2] https://www.titan.com/articles/private-equity-returns
[4] https://www.investopedia.com/articles/markets/011116/worlds-top-10-private-equity-firms-apo-bx.asp
[5] https://online.hbs.edu/blog/post/private-equity-performance
[6] https://www.schroders.com/en-au/au/adviser/insights/how-do-private-equity-funds-measure-performance/
[7] https://gitnux.org/private-equity-performance-metrics/
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