Pantheon: Carried Interest A Key Element in Later-Stage PE Fund Performance

Mar 25 2016 | 12:13am ET

As the debate around carry interest rages in U.S. political circles, a new study by global private equity investor Pantheon suggests it is a major determinant of later stage performance in private equity funds. 

The research examined two features of the lifecycle of private equity funds. First, it explored the potential impact of carried interest in aligning GPs with LPs in terms of generating strong performance later in the fund’s life. Pantheon collected performance data on almost 700 private equity funds globally and looked at whether there was a difference in the subsequent or “incremental” performance generated, from any given point in time, depending on whether or not a fund was estimated to be in-Carry.

The company’s hypothesis, which was supported by the data, was that once a fund had crossed its Carry threshold, incremental performance until liquidation was likely to exceed that generated by funds of the same age that had not crossed the Carry threshold. 

Secondly, Pantheon considered the extent to which PE funds have historically “jumped” across quartile rankings. The implication here is that the stickier or more persistent the quartile ranking of a fund at an early stage, the more visibility one has over the potential future performance of a PE portfolio. 

Other key findings of the report:

  • Based on the dataset and period under observation, Carry appears to be a determinant of later stage performance in private equity funds.
  • The funds in Pantheon’s dataset that were in Carry as at year nine were able to generate at least 3% p.a. extra in terms of their median incremental IRR, compared to funds not in Carry and of an equivalent age. 
  • If a fund is not in Carry by approximately year seven, this appears to constitute a warning sign about its potential incremental performance at least in relative terms compared to funds that had crossed the Carry threshold. 
  • Final fund quartile performance rankings appear to emerge relatively early. By year five, the top quartile buyout funds in our dataset already had less than a 13% probability of generating final performance that was below the median. 
  • The fate of bottom quartile funds also emerged early on: as soon as year three, bottom quartile buyout funds in our dataset had less than a 27% probability of ultimately performing better than the median.
  • The persistence of quartile performance appears to be particularly strong in venture: final quartile performance emerges sooner, particularly for bottom quartile funds.
  • The findings may be relevant for private equity managers seeking to manage older vintage PE portfolios, Pantheon wrote, or for LPs seeking to actively manage their portfolios at an earlier stage, on a more tactical basis, or from the perspective of secondary investment opportunities.

Founded in London in 1982, Pantheon is a leading global private equity fund investor bought by Affiliated Managers Group in 2010. The company manages approximately $33 billion globally across primary investments, global secondary and infrastructure investments, and customized SMA programs.

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