The returns generated by UK managed private equity funds have been sufficiently attractive to warrant great interest in this asset class, particularly from experienced US institutional private equity investors and increasingly from continental European investors.

The BVCA/WM performance survey is "one of the most complete country specific datasets on the performance of venture capital funds in the world."

The London Business School report carries out a four-fold performance analysis. First, it calculates industry level returns over different time horizons. Second, it compares the returns both annually and on a cumulative basis to the main comparators. Third, it examines the absolute returns (multiples). Fourth, it compares the returns to the European and US private equity industries.

The long-term performance of the UK private equity industry since 1980 stands at over 14% per annum net of all costs and fees.

"A short-term IRR should be discussed in conjunction with the levels of investment activity since it is not a sufficient indicator to assess the industry-level performance of this asset class."

Over the period between 1987 and 1998, cumulative private equity returns have outperformed all principal UK comparators.

From 1987 (the first year for which individual fund valuations are available) to 1998, the cumulative annualised private equity returns were slightly higher than quoted equity returns (14.8% and 14.6% respectively). All other major UK asset classes were outperformed by a substantial margin of 240 to 460 basis points.

Since 1992 cumulative private equity returns have outperformed UK equities by a substantial margin of 910 basis points and other UK asset classes by a margin of 1270 and 1520 basis points.

These figures are based on a comparison between historical private equity cash flows and identical cash flows invested in and divested from index-tracking derivatives for other asset classes (for annual and cumulative returns, see Figures 8 and 9 below).

Several young funds that have not yet reached maturity (those funds raised within the last four years) have already produced returns in excess of 15% per annum. The returns of these funds are likely to increase as they reach maturity and exit their investments.

The full London Business School report analyses the returns of UK managed limited partnership private equity funds in great detail. It concludes that the methodology adopted by The WM Company and the BVCA to measure performance and the use of the Internal Rate of Return (IRR) is the most appropriate for the asset class. Private equity returns are analysed net of all costs and fees.

"An IRR of 15% does not signify that a compound return of 15% over a 10 year period is achieved for the totality of committed capital. As a result, the returns of the partnership reported only refer to the amounts of drawn funds and the time during which they have been working for the fund's portfolio."

Interim fund IRRs follow the so called J-curve pattern. The J-curve (shown above) is caused by the management fee and start-up costs of the private equity limited partnership usually being financed out of the first draw downs in the first year, followed by the general partners starting to invest. BVCA valuation guidelines recommend investments should be valued at cost during the early years. Upwards adjustments of the values are made only when an investee firm has demonstrated a substantial increase in value, usually following receipt of audited financial statements. In comparison, poor performing investments are written down as soon as problems are identified, generally impacting earlier rather than later. When the first successful realisations are made, the return curve rises steeply. For MBO funds, the time period required to reach positive IRRs can be shorter than for early stage and development funds depending on the state of public equity markets.

During the 1990s, the UK buy-out and generalist funds have outperformed their US and European peers. Compared with the USA, the UK funds have recently had even stronger performance. UK returns have also been consistently higher than the aggregated returns produced by European private equity funds².

Data from the London Business School report, graph drawn by the BVCA. NB. Data from USA and UK are measured to 31 December 1998. USA data includes mezzanine funds; European data includes UK funds (accounting for 66% of the total amount of funds analysed) and is measured to 31 December 1997 (the latest figures available).

Mature UK funds (those raised more than four years ago) have already returned 131% to their investors while still retaining a conservatively valued 44% of the original drawn down capital within their portfolios.

² As surveyed by the EVCA (European Venture Capital and Private Equity Association) in 1997.

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