Why Manager Selection Is Critical for Private Equity Investing

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Private equity can play an important role in an investor’s portfolio, offering strong return potential, increased diversification, and expanded investment opportunity. But a key step to the success of these investments is selecting the right manager. Why? The potential for significant performance variability is far greater in the private markets than the public markets.

Historical data reveals a more than 14-percentage-point performance differential between the top-performing private equity managers and the bottom-performing managers over the past 10 years (see chart). For comparison, the performance difference for public large-cap stocks over the same period was 4.8 percentage points. Thus, performance dispersion is an important consideration when it comes to private investments and manager selection is critical.

What’s driving the performance dispersion in private equity?

The concept of performance dispersion refers to the range of returns achieved by different investments or investment managers over a specified period. It quantifies the gap between the best and worst performers, indicating the variability – or spread – of returns within a particular market or investment strategy. In the context of private equity investments, performance dispersion refers to the variability in returns across different private equity funds.

Historical data has shown that skilled active management can add more value in some asset classes than others. While performance dispersion in public equity funds tends to be relatively low due to the speed and transparency of available information which makes these markets highly efficient, that’s not the case in private markets. Private equity asset classes have historically exhibited higher performance dispersion as measured by interquartile spreads.*

While there are roughly 4,500 publicly traded companies in the U.S. today, the number of private companies is far larger – more than 30 million. Because the investable universe is much larger, and since these companies have less readily available financial and operational information, private equity is a less efficient asset class than public stocks. This means that skilled investment managers can potentially take advantage of the larger mispricing opportunities to add value.