Investment companies listed on the stock market are generally regarded as high-risk, and in the stock-market crash some total failures attracted much publicity. In addition, some large companies, such as 3i, Softbank and Jafco, are well-known. But even experts in the field know little more about global connections in this investment category, once greeted with euphoria, today pushed to one side. It is therefore welcome that a first systematic, long-term study on publicly traded private equity (PTPE) is now available. The most surprising result of the work carried out by Professor Heinz Zimmermann, Michel Degosciu and Hans Christophers of the University of Basle Centre for Economics is that world-wide there are 287 private equity companies listed on the stock market, many more than had previously been assumed.
The study begins in 1986. At that time there were world-wide 16 companies listed on a stock market, with a total market value of $738m (E599m). As a result of their performance and 57 public flotations, by the end of 1994 their capitalisation had grown to $17 bn. With that, private equity was indeed still not a major investment category, but its success was being talked about among specialists. It attracted new investors, so that in the second half of the 1990s the number of holding companies rose to 266.
In parallel with this, market capitalisation grew spectacularly. At its highest point, in February 2000, capitalisation reached a peak of $293bn. It had increased by a factor of 17 in only five years. The subsequent debacle was all the more striking. By the spring of 2003 the stock-market value of the quoted private-equity companies had fallen dramatically, to $23.9bn.
In order to be able to calculate the yields from PTPE, the Basle market researchers created a comprehensive PTPE-Index, which – in contrast to previous surveys – was to be based on market values only. The investment segment is however distinguished by certain peculiarities. Many shares are traded so rarely that they hardly come into question as investments. On the other hand, some giants have such high capitalisation that they would dominate a capital-weighted index excessively. The three authors therefore decided on an index which includes only the 114 most liquid shares, and gives equal weight to each.
From 1986 to 2003 it exhibits a surprisingly high performance of 16% pa. Private equity thus shows a clearly higher yield than the MSCI World-Share Index (6.4% pa). Even in comparison with hedge funds it does well. The CSFB Tremont Hedge Fund Index achieves a long-term average annual yield of 11.1%.
The PTPE-Index can also be compared with the ‘Internal Rate of Return’ (IRR) of private equity published by the European Private Equity & Venture Capital Association (EVCA). For the period 1993 to 2002 this is 13.6%, and so lies within a whisker of the PTPE-Index yield (13.8% in the same period). Because of the entirely different method of calculation, the matching can only be by chance. But in any case there are now two possibilities for assessing the profitability of private equity realistically.
The volatility of the index is 19.3%, and lies clearly above that of the MSCI World (15.2%). When looking at the risks, it must also be taken into consideration that the correlation of
private equity and shares is 43% overall, but that in downturns it rises markedly. PTPE cannot therefore provide any diversification benefit in difficult times, but in fact increases the cyclical character of a portfolio. Private equity should therefore be built up at the expense of shares, not of bonds.
The loss which private equity investments have recorded in the recent past probably deters many investors. It should however be borne in mind that the period from 1999 to 2003, with its enormous fluctuations in value, is not typical. The PTPE-Index also exhibits years with moderate volatility, and after an extreme expansion and contraction has only returned to its long-term trend again.