I asked asset managers the following question: “How do you assess PE (Private Equity) funds, and their leaders) to determine which fund to invest in?”  Asset managers included: pension funds, large global asset managers, and family offices.  Insight was also provided by advisors to asset managers.

The following illustrates the consolidated set of assessment approaches used.  Many asset managers use similar approaches.  Some approaches are used by only one asset manager.  This document is focused on what is done, not on how assessment is done or specific analytical techniques.  (Some asset managers shared their techniques.  That information is confidential). There is no recommendation as to what is a good or bad approach.

Analysis of performance

• PE firms may provide detailed financial and operational data on all portfolio companies.
• What is the consistency of returns over time? Many respondents noted that persistence of returns is declining, perhaps due to high purchase valuations leading to difficulty in PE partners achieving significant value increase.
• What have been the exit results? What have been the successful and unsuccessful exits?
• How much additional return has the PE fund been generating, taking into account both financial leverage and public market returns of similar companies?
• Avoid funds and firms with historical returns in the 3^rd or 4^th

Analysis of strategy

• Industry focused or generalists?
• Limited range of deal size?
• How consistent has the strategy been over time?
• What is the leverage being used? 3-4 times or 7-8 times?
• Is the strategy to have similar returns from all portfolio companies or depend upon one company to provide outstanding returns which compensate for poor returns with other companies? This impacts the volatility of the portfolio.
• Is the PE firm due diligence approach supporting the strategy? Do reference checks with the portfolio companies confirm the stated due diligence approach and fund strategy?

Analysis of PE fund partners

• How long have they been with the fund?
• What’s been their previous history?
• What have been their personal achievements, rather than the achievements of the companies they’ve been with?
• What has been the partner experience with business operations, rather than finance or investment banking?
• If the strategy is changing, how has the PE team talent changed to bring in the experience with the new strategy?
• How much of the fund capital is provided by the partners?
• How have the partners increased the value of portfolio companies, in addition to providing capital?
• How do portfolio company CEOs like working with the partners?
• Run background checks on the partners: social media and publicly available records.
• Hire a third party to work with the PE partner to conduct a deep psychological and historical analysis. This could include questioning colleagues, subordinates, other asset managers, friends, and family.  This could conclude with a multi-hour walk through with the partner of their entire life

Relationship Management – Between asset managers and PE funds.

• Proactively seek out emerging PE funds.
• The asset manager re-underwrites each new PE firm deal with different staff, to avoid the bias of personal relationships.
• The asset manager maintains a long-term personal relationship with the PE fund partner(s).

Observations that were made to me

• There are lots of good PE firms and partners. Asset managers can only deal with a small number of PE firm.  Each firm requires management time.
• There are not enough good opportunities for PE funds. There is over a trillion dollars of PE capital not invested, with valuations at all time highs.
• Sovereign wealth funds are a partial enabler of high valuations, because some funds are satisfied with single digit returns.

My observations

• Some asset managers make a major effort in assessing the talent of individual PE partners.
• Some asset managers are heavily focused on performance metrics.
• The nature and degree of quantified, comparative (or benchmark) analysis varies enormously among asset managers.