© cumming & johan (2013)venture capital and private equity contracting listed private equity...

© Cumming & Johan (2013) Venture Capital and Private Equity Contracting

Listed Private Equity

Cumming & Johan (2013, Chapter 8)

1


Limited partnerships: PE firms are the management company that operate a PE fund (or a set of PE funds

IntroductionTheory

DataTests

Conclusion

Institutional Investors

PE Fund

Investee Firm

Returns Capital

Equity, Debt,Warrants, etc.

Capital

Recall:Cumming and Johan (2013 chapter 5)show internationaldifferences in PE fundstructures depends onhuman capital andinstitutional setting

2


Listed Private Equity is Different

IntroductionTheory

DataTests

Conclusion

• Either the PE fund or the PE firm is listed on a stock exchange

• A listed private equity firm (the management company), provides shareholders an opportunity to gain exposure to the management fees and carried interest earned by the investment professionals and managers of the private equity firm. – E.g., Blackstone Group on June 22, 2007 . Traded on NYSE under symbol BX

• A listed private equity fund or similar investment vehicle, which allows investors that would otherwise be unable to invest in a traditional private equity limited partnership to gain exposure to a portfolio of private equity investments– E.g., Kohlberg Kravis Roberts raised $5 billion in IPO for KKR Private Equity

Investors (“KPE”), Euronext in Amsterdam (ENXTAM: KPE) on April 18, 2006.– E.g., Fortress, February 7 2009

3


Blackstone IPO

IntroductionTheory

DataTests

Conclusion

• On March 22, 2007, the Blackstone Group filed with the SEC to raise $4 billion in an initial public offering.

• The offering was underwritten by Morgan Stanley and Citigroup, with smaller roles played by Merrill Lynch, Lehman Brothers, Credit Suisse and Deutsche Bank.

• On June 21, Blackstone swapped a 12.3% stake in its ownership for $4.13 billion in the largest U.S. IPO since 2002.

• Traded on the New York Stock Exchange under the ticker symbol BX, Blackstone priced at $31 per share on June 22, 2007.

4


Stock Performance of Blackstone Group

IntroductionTheory

DataTests

Conclusion

5


Fortress IPO

IntroductionTheory

DataTests

Conclusion

• On February 9, 2007 Fortress became the first hedge fund and private equity company to go public in the United States when it sold an approximately 39% stake and raised $634 million.

• Goldman Sachs and Lehman Brothers were the lead underwriters of the offering, along with Bank of America Securities, Citigroup and Deutsche Bank.

• Fortress made an impressive market debut and after the first day of trading, its shares were selling at a 68% premium compared to the offer price of $18.50.

6


Stock Performance of Fortress

IntroductionTheory

DataTests

Conclusion

7


Broader Statistics on Listed Private Equity

IntroductionTheory

DataTests

Conclusion

• How many funds currently?– LPEQ (Europe): 80 investable listed private equity companies as at 2008, with market

capitalisation of £22 bn (€25 bn) of which £11 bn are London-listed companies – Standard & Poor's (US): 80 listed private equity businesses trading on developed

market exchanges, with market capitalization of more than US$ 250 million.

• Performance expectations for the asset class?– Tends to show underperformance– Caveat: many studies include VCTs, and LPEQ argues not listed PE

• Note: tax subsidized schemes like LSVCCs (Canada) and VCTs (UK) are not considered listed private equity– Many statutory constraints, hurts governance/performance

8


Main Issue in this Chapter

IntroductionTheory

DataTests

Conclusion

• Given mixed performance to date, who invests in listed private equity, and why?

9


Prior work (1 of 2)

IntroductionTheory

DataTests

Conclusion

• Lahr and Kaserer (2009 WP): – 1992-2008– 79 ordinary funds and 21 listed PE funds– Listed PE funds start at an initial premium of -2.5 % and

adapt to the long-term average of -21 % after two years. – Premia predict future returns and are explained by liquidity

but not by investor sentiment or the fund's investment degree.

– Private equity fund premia seem to depend on credit markets and systematic risk.

10


Prior work (2 of 2)

IntroductionTheory

DataTests

Conclusion

• Jegadeesh, Kräussl and Pollet (2009 WP)– 26 private equity fund-of-funds and 129 listed private equity funds over

1994-2008, – Estimate the market’s expectation of unlisted private equity funds (via

fund-of-funds) abnormal returns (and net of their fees) to be 1-2% above the market accounting for risk,

– Estimate the market’s expectation for listed private equity abnormal returns is zero to marginally negative.

– Betas of listed private equity and unlisted private equity (via fund-of-funds) are close to one.

– Private equity fund returns are positively correlated with GDP growth and negatively correlated with credit spread.

11


New insights in this chapter

IntroductionTheory

DataTests

Conclusion

• First to document who invests in the asset class of listed private equity, and why

• Perspective of institutional investors

• Data from LPEQ and Preqin– Leading source of information on Listed Private Equity– 171 institutional investors in Europe, 2008-2010

12


Who Invests? Search Costs

IntroductionTheory

DataTests

Conclusion

• Hypothesis 8.1A: Listed private equity is a more attractive asset class for smaller institutional investors.

• Hypothesis 8.1B: Listed private equity is more commonly considered by institutional investors based in the UK than their counterparts in continental Europe.

13


Who Invests? Specific Human Capital

IntroductionTheory

DataTests

Conclusion

• Hypothesis 8.2: Listed private equity is more likely to be considered by an institutional investor whose decision making is delegated to an equities team as compared to delegation to a private equity team or an alternative asset team.

14


Who Invests? Liquidity Time Preference

IntroductionTheory

DataTests

Conclusion

• Hypothesis 8.3: Listed private equity enables institutional investors to achieve their target private equity allocations quicker, and as such, institutions that invest in listed private equity are more likely to adjust their listed private equity allocations over time in response to slower adjustments to limited partnership private equity allocations.

15


Data

IntroductionTheory

DataTests

Conclusion

• 171 institutional investors in Europe– 34% investors have listed private equity in their investment mandate– 18% investors have a variable listed private equity allocation over time

• For investors that have listed private equity in their investment mandate, the average allocation to listed private equity relative to limited partnership is 8.34%

• For all investors in the sample, the percentage of investments into listed private equity relative to total assets under management is 0.54% – And 1.60% for the subset of investors with listed private equity in their

investment mandate

16


Characteristics of Investors in Sample

IntroductionTheory

DataTests

Conclusion

• Size– The average institutional investor in the sample manages over €35.5

billion, with the median at €2.2 billion.

• Types– 1 investment bank, 2 endowments, 59 family offices, 14 banks, 24 private

pension funds, 24 insurance companies and 44 public pension funds.

• Countries: – UK (50), Switzerland (26), Denmark (5), Netherlands (12), Finland (10),

Germany (26), Liechtenstein (2), Sweden (7), France (3), Italy (2), Austria (4), Belgium (2), Greece (2)

17


Some Attractions to Listed PE

IntroductionTheory

DataTests

Conclusion

• 89% report improved liquidity

• 57% report afforded access to private equity without any delay

• 46% report an attractive way to invest after the “J-curve” – meaning lower returns at the start of a fund’s life due to management

fees and other costs, but higher returns later in a fund’s life as capital is invested and investments are harvested

• 67% report simplified administrative burdens and cash flow management relative to limited partnership private equity.

18


Table 2: Comparison Tests

IntroductionTheory

DataTests

Conclusion

• A significantly higher proportion of private pension funds invest in listed private equity (24%) than those that do not (9%),

– In Europe, private pension funds often have significantly smaller investment teams than public pension funds, and as such have less time and expertise to carry out due diligence and review and negotiate limited partnership contracts.

– Smaller pension funds may use listed private equity as an easy way to obtain diversification, either via a listed fund of funds or via a portfolio of direct listed private equity vehicles.

– Investing in listed private equity not only lowers due diligence and review costs, but also improves diversification.

19


Table 8.2. Comparison Tests

Listed PE Part of Investment Mandate Listed PE Not Part of Investment MandateComparison of

Means (or Proportions)

Mean (or Proportion for Dummy Variables)

MedianMean (or Proportion for Dummy

Variables)Median

Institutional Investor Characteristics

Assets Under Management € 62,179.60€

2,224.10€ 21,819.40

€ 2,140.00

0.86(P’=0.81 for

comparison of medians)

Family 0.26 0.00 0.39 0.00 -1.70*

Private Pension Plan 0.24 0.00 0.09 0.00 2.72***

Public Pension Plan 0.22 0.00 0.25 0.00 -0.34

Bank 0.09 0.00 0.08 0.00 0.15

Insurance Company 0.17 0.00 0.12 0.00 0.86

Investment Bank 0.00 0.00 0.01 0.00 -0.72

Endowment 0.02 0.00 0.01 0.00 0.48

Fund of Funds 0.00 0.00 0.01 0.00 -0.72

PE Firm 0.00 0.00 0.01 0.00 -0.72

Investment Manager 0.00 0.00 0.04 0.00 -1.4520


Listed PE Part of Investment Mandate Listed PE Not Part of Investment MandateComparison of

Means (or Proportions)Table 8.2. (Continued)

Mean (or Proportion for Dummy

Variables)Median


Median

Location

UK 0.33 0.00 0.27 0.00 0.85

Switzerland 0.17 0.00 0.14 0.00 0.53

Netherlands 0.12 0.00 0.04 0.00 1.85*

Finland 0.07 0.00 0.05 0.00 0.42

Germany 0.07 0.00 0.19 0.00 -2.05**

Sweden 0.09 0.00 0.02 0.00 2.14**

Denmark 0.00 0.00 0.04 0.00 -1.63

Liechtenstein 0.02 0.00 0.00 0.00 1.40

Iceland 0.03 0.00 0.00 0.00 1.99**

Norway 0.03 0.00 0.04 0.00 -0.31

France 0.00 0.00 0.04 0.00 -1.45

Italy 0.00 0.00 0.02 0.00 -1.02

Austria 0.00 0.00 0.03 0.00 -1.25

Belgium 0.00 0.00 0.02 0.00 -1.02

Greece 0.00 0.00 0.01 0.00 -0.72

Pan European 0.07 0.00 0.10 0.00 -0.62 21


Listed PE Part of Investment Mandate Listed PE Not Part of Investment Mandate

Comparison of Means (or

Proportions)Table 8.2. (Continued)


MedianMean (or Proportion for Dummy

Variables)Median

Internal Investment Decision Making

The Private Equity Team 0.22 0.00 0.27 0.00 -0.59

The Equities Team 0.04 0.00 0.04 0.00 0.00

The Alternative Asset Team 0.05 0.00 0.11 0.00 -1.19

The Board / Investment Committee 0.43 0.00 0.32 0.00 1.45

Consultant 0.17 0.00 0.13 0.00 0.70

Beliefs of Decision Makers

Listed Private Equity Offers More Liquidity than Limited Partnerships

0.90 1.00 0.88 1.00 0.23

Listed Private Equity Allows Access to Private Equity Immediately

0.74 1.00 0.48 0.00 3.29***

22


Regression Analyses

IntroductionTheory

DataTests

Conclusion

• Table 4 Logit Analysis of Listed PE Allocation– Whether there is a listed PE allocation– Whether the listed PE allocation changes over time– Whether or not listed PE investment depends on fund managers

simultaneously managing private PE funds

• Table 5 Percentage Allocation to Listed PE– Percentage of listed PE versus other PE– Percentage of listed PE relative to total assets– Difference between target PE allocation and actual PE allocation

23


General Form of Econometric Models

IntroductionTheory

DataTests

Conclusion

• Invest in Listed Private Equity = f [constant, institutional investor characteristics (size, type), location, decision making (equities team, private equity team, etc.), beliefs of decision makers]

• Present two sets of explanatory variables to show robustness.

– 1st one includes assets under management in a linear specification with dummy variables for private and public pension funds; additional dummy variables for other types of institutional investors were excluded for reasons of collinearity.

– 2nd one uses the natural log of assets under management to account for a potential decreasing importance of size on the decision to invest as size gets larger. Also, the interaction between type of institutional investor and size is analyzed to explore whether larger public pension funds behave differently than larger private pension funds.

24


Table 8.4Listed PE Part of Investment

MandateModel 1

Listed PE is a Variable Allocation over TimeModel 3

Listed PE Investment Decision Depends on Whether Fund also

has a Private PE FundModel 5

Marginal Effect t-statistic Marginal Effect t-statistic Marginal Effect t-statisticConstant -0.879 -2.563** -0.359 -2.524** -0.212 -1.446Institutional Investor CharacteristicsLog (Assets Under Management) -1.518E-02 -0.583 -1.005E-02 -1.027 -1.822E-02 -1.269Family 0.457 1.589 0.219 1.057 0.136 0.581Private Pension Plan 0.600 2.818*** -0.053 -1.044Public Pension Plan 0.259 0.830 0.013 0.126 0.077 0.781Bank 0.537 2.107** 0.148 0.539 0.332 1.107Insurance Company 0.598 2.703*** 0.276 0.868 0.263 1.308LocationUK 0.335 2.501** 0.093 1.105 0.289 1.839*Switzerland 0.192 1.255 0.126 1.119 0.224 1.243Netherlands 0.364 1.929* 0.294 1.080Finland 0.209 0.860Germany -0.069 -0.509 0.016 0.251 0.012 0.119Sweden 0.601 4.467*** 0.727 3.353*** 0.043 0.284Internal Investment Decision MakingThe Private Equity Team -0.022 -0.187 -0.012 -0.267 0.104 1.036Equities Team 0.099 0.352 0.003 0.028 0.074 0.450The Alternative Asset Team -0.207 -2.236** -0.047 -1.485 0.008 0.082The Board / Investment Committee 0.022 0.220 0.012 0.275 -0.077 -1.589Consultant Advised of Listed PE 0.136 0.961 0.051 0.686 0.043 0.444Beliefs of Decision MakersListed Private Equity Offers More Liquidity than Limited PartnershipsListed Private Equity Allows Access to Private Equity Immediately

0.253 2.849*** 0.241 3.295*** 0.062 1.460

Listed Private Equity Companies are Attractive to Invest After the J Curve

0.209 2.377** 0.095 1.857* -0.026 -0.589

Listed Private Equity Simplifies the Administrative Burden and Cash Flow Goodness of FitPseudo R2 0.218 0.402 0.233 25


Summary of Table 4 Findings (1 of 2)

IntroductionTheory

DataTests

Conclusion

• Support for Hypothesis 1A– Private pension funds are 60% more likely to invest in listed private equity

• Relative to public European pension funds, private European pension funds have fewer individuals on the investment team, which makes the added due diligence and costs and time with limited partnership private equity much less attractive.

– Furthermore, listed private allocations are less likely to be variable for private pension funds and larger private pension funds

• Support for Hypothesis 1B– Model 1 (Model 5) further shows listed private equity is 33.5% (28.9%)

more common for institutional investors based in the UK

26



IntroductionTheory

DataTests

Conclusion

• Support for Hypothesis 2– Relative to decisions allocated to an equities team, decision making allocation

reduces the probability of investment in listed private equity by• 20.7% when allocated to the alternative asset team (Model 1)

• Support for Hypothesis 3– Institutional investors that use listed private equity to obtain access to private

equity immediately are 24.1% more likely to have variable allocations to listed private equity over time (Model 3)

– Model 3 also shows that institutions investing with a view to investing after the J-curve are 9.5% more likely to invest in listed private equity with a variable allocation, while Model 4 shows preference for simpler cash flow and administrative burdens are 17.3% more likely to have variable listed private equity allocations.

27


Percentage of Listed PE versus

other PE Model 8

Percentage of Listed PE Relative to Total Assets

Model 10

Difference between Percentage of Target PE Allocation and Actual

PE Allocation Model 12

Coefficient t-Statistic Coefficient t-Statistic Coefficient t-Statistic

Constant -3.358 -4.417*** -3.481 -7.138*** -4.834 -19.454***Institutional Investor CharacteristicsLog (Assets Under Management) -1.713E-01 -2.700*** -1.279E-01 -2.488** 1.122E-01 4.287***Family 0.035 0.074 -0.093 -0.400 0.289 1.406Private Pension Plan -0.317 -0.630 -0.305 -1.353 0.032 0.216Public Pension Plan -0.297 -0.612 -0.267 -1.163 -0.154 -1.112Bank 0.562 1.055 0.285 1.081 -0.653 -3.218***Insurance Company 0.597 1.372 -0.090 -0.458 -0.329 -2.163**LocationUK 0.473 2.336** 0.141 1.923* 0.210 1.482Switzerland 0.754 2.792*** 0.525 2.273** -0.306 -2.579**Netherlands 0.778 2.014** 0.483 2.664*** 0.004 0.034Finland -0.167 -0.328 0.057 0.519 0.391 1.913*Germany 0.165 0.758 0.111 0.905 -0.296 -2.721***Sweden 1.488 4.041*** 0.747 2.912*** 0.060 0.240Internal Investment Decision MakingThe Private Equity Team -0.274 -1.300 -0.082 -0.872 -0.253 -2.275**Equities Team -0.145 -0.295 -0.180 -1.600 -0.239 -0.755The Alternative Asset Team 0.039 0.101 0.094 0.691 -0.349 -2.733***The Board / Investment Committee -0.008 -0.039 -0.059 -0.489 -0.262 -2.272**Consultant Advised of Listed PE -0.102 -0.459 -0.156 -1.476 -0.221 -1.964**Beliefs of Decision Makers

Offers More Liquidity -0.085 -0.361 -0.148 -1.385 -0.069 -0.546

Simplifies the Administrative Burden 0.595 3.726*** 0.252 2.450** 0.028 0.289

Listed Private Equity Allocation

Dummy=1 for Currently Invested in Listed PE -0.188 -1.820*Dummy=1 for Listed PE Allocation Varies Over Time

0.446 2.859***

Goodness of FitPseudo R2 0.101 0.154 0.199 28



IntroductionTheory

DataTests

Conclusion

• Support for Hypothesis 1A– Larger institutional investors invest less in listed private equity relative to limited partnership private

equity, • Economic significance: a change in institutional investor size from €5 billion to €10 billion

reduces the amount invested in listed private equity relative to total equity by 0.5%• This is significant because the average amount invested in listed private equity versus limited

partnership private equity is 2.83% and the average institutional investor in the sample manages over €35.5 billion

• Support for H2A– Models 7-10 provide similarly strong support for Hypothesis 8.1B for location in the UK versus continental Europe. – Also, the data indicate strong levels of investment in listed private equity in Switzerland, Sweden and the Netherlands.

• No support for Hypothesis 2– Models 7-10 do not provide strong support for Hypothesis 8.2.

• Support for Hypothesis 3– Allocations to listed private equity versus limited partnership are approximately 5% higher for

investors that believe listed private equity affords access to private equity immediately

29



IntroductionTheory

DataTests

Conclusion

• How far away the institutional investor is from its target private equity allocation?– Strongest support for Hypothesis 3

• Institutions that use listed private equity are approximately 5% closer to their desired private equity allocation relative to institutions that do not invest in listed private equity.

– Additional evidence supports Hypothesis 1A• Larger public pension funds tend to be farther away from their

desired allocations to private equity, consistent with Hypothesis 1A– Additional evidence supports Hypothesis 2

• Allocations made by an equities team tend to be closer to their desired private equity allocation

30


IntroductionTheory

DataTests

Conclusion

Summary and Conclusions

31


Conclusions (1 of 2)

IntroductionTheory

DataTests

Conclusion

• The public equity market’s expectations regarding current expected returns to investment in listed versus limited partnership private equity are not very attractive (Jegadeesh, Kräussl and Pollet, 2009) .

• Worth exploring factors that affect institutional investor portfolio management and allocations to private equity, and in particular raises the question of how institutional investors allocate capital within different segments of the private equity market.

• We explore for the first time various factors that influence such capital allocation decisions to listed versus limited partnership private equity funds.

32


Conclusions (2 of 2)

IntroductionTheory

DataTests

Conclusion

• Size and type– Smaller institutional investors allocate capital to listed private equity, as do private

(not public) pension funds, and those with a preference for liquidity and are based in the UK (not continental Europe).

• Decision making– The empowerment of decision making to an equities team has a pronounced

impact for investment in listed private equity. – Where institutions allocate decision making to a private equity team, an alternative

asset team, or the board / investment committee, investment in listed private equity is much less common.

• Institutions invest in listed PE to reduce search costs, and achieve a desired investment exposure in as timely a manner as possible.

33


Supplementary Issues with Listed Private Equity

(1) Performance Measurement

(2) Government Created Investment Schemes that look like listed PE

34


(1) Performance Measurement

• PE investments take a long time to exit in IPO, acquisition, secondary sale, buyback or write-off (2-5 years common)

• Valuations of portfolio companies infrequently change prior to exit, implying betas are low– See Chapter 22 for valuation methodologies– Listed private equity indices of performance are difficult to construct (

http://www2.standardandpoors.com/spf/pdf/index/SP_Listed_Private_Equity_Index_Methodology_Web.pdf)

• Fund managers have perverse incentives to over-value unexited investments to attract new funds from institutional investors (Chapters 4 and 22)

35


(2) LSVCCs are like Listed PE funds, but Not

• Canadian LSVCCs Labour Sponsored Venture Capital Corporations– Chapter 9 of this book– Tax-subsidized Venture Capital Funds– Investors are individuals, not institutions– Massive tax breaks for $5000 investments (RRSP eligible, plus 15% federal

and provincial)– Statutory covenants that are inefficient, such as <2 year time limits to

reinvest contributed capital

• Similarly, UK VCTs Venture Capital Trusts are not considered Listed PE by LPEQ

36


0

5

10

15

20

25

92 93 94 95 96 97 98 99 00 01 02 03 04

$Can

(bill

ions

of 2

004

dolla

rs)

Year

Figure 9.1. Venture Capital Under Management by Investor Type in Canada: 1992-2004

Corporate Government Institutional Direct / Foreign Labour Sponsored Private Independent

37


-200

0

200

400

600

800

1000

1200

1400

Ind

ex V

alu

e (A

dju

sted

to

Sta

rt a

t 0

on

Sep

tem

ber

199

2)

Date

Figure 9.3. Selected Indices 1992 - 2005

Globe LSVCC Peer Index Globe Canadian Small Cap Peer Index

TSE 300 Composite Index / TSX Total Return Index US Venture Economics Index

30-Day Treasury Bill Index

38

© cumming & johan (2013)venture capital and private equity contracting listed private equity...

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