Investors in private equity have a chance of achieving top performance over time by selecting the top quartile managers. The funds of top quartile managers have been seen to consistently over-perform over time, and their competition has not been able to catch up.  This makes private equity an attractive asset class, but also highlights that the selection process is well worth investing in.

On the contrary, a portfolio of mutual funds will revert to the mean over time and a portfolio consisting only display the same characteristics. 

In a study done by Boston Consulting Group* of 1750 deal transactions between 2000 and 2006, the theory of how once high performing public companies and mutual funds revert towards the mean in the next time period or fund, is clearly demonstrated. The research also proved that this is clearly not the case for the top performing private equity funds. 

The comparison between public and private equity companies discounts for differences in leverage illiquidity and adds a stability premium for private equity held companies (these are selected by the managers based on less volatile earnings than the mean). With these adjustments the study shows that the average private equity fund do not “beat the market”, but the top quartile private equity funds consistently do.

Private equity as an asset class has several industry characteristics which are not found in other asset classes, and this is therefore both a reason to invest in private equity, and a prerequisite for careful private equity manager selection.

Sources:

*(Meerkat, Brigl, Prats,Lichtenstein, Herrera & Rose (2008) “The advantage of persistence – How the best private equity firms beat the fade”, online source) Boston Consulting Group. Available from: http://209.83.147.85/publications/files/Private_Equity_Feb_2008.pdf [Accessed 24.11.2009]