CBR Briefing #1

How private-equity firms lose when they manipulate returns
Private-equity firms trying to raise new capital sometimes overstate fund returns, but investors aren’t fooled.

No gain in gaming | Excess returns of private-equity funds that had no follow-on fund, and those that were early and late to open a follow-on fund chart

Research suggests that while some underperforming private-equity fund managers overstate asset values, managers at the best-performing funds tend to understate returns.

  • Institutional investors usually detect when private-equity fund managers overstate asset values and shy away from new funds started by the same managers, according to research by Chicago Booth’s Steve Kaplan, with Gregory W. Brown and Oleg R. Gredil of the University of North Carolina at Chapel Hill.
  • When private-equity firms market new funds, some report abnormally high returns to their existing funds.
  • Such manipulation seems limited to some underperforming funds. These fail to raise money for follow-on funds, suggesting that investors see through the manipulation.
  • In one-off funds, excess returns rise when firms are apparently making a last-ditch effort to open a new fund, then fall (see chart).
  • Manipulation is more likely when fewer new funds are opening and capital is scarce.
  • By contrast, managers at the best performing private- equity funds tend to understate returns, to insure against being misconstrued by investors as manipulating fund data.
  • Kaplan, Brown, and Gredil analyzed 220 investment programs accounting for more than $1 trillion in capital.

Click here to download this briefing as a PDF.

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