Sunday, March 10, 2013

Chasing the next hot market

The slide below from Abbott Capital (a private equity fund of funds) tells an amazing story of private equity investing. The first half of the slide is a table that shows returns (IRR) for the full spectrum of private equity investing - from "early venture" to "mega buyouts". For those unfamiliar with private equity, each cell shows the annualized return for funds of that "vintage year" (the year the fund was raised) through today. For example the 2000 "large buyout" funds produced an 18.6% annualized average return over their life (typically 7-9 years).

The lower chart shows the dollar amounts raised for the two major private equity groups over the same time period: venture and buyout.

Source: Abbott Capital Management LLC (click to enlarge)

In the late 90s venture investing became fashionable. But by time large amounts of capital poured into the asset class, the party was already over. The best performing investments had been made before the wave of dollars came into venture funds. Those who came in at the height of this investing "craze" ended up with sub-par returns.

But investors don't seem to learn about chasing the next "fashionable" product. They piled into the buyout space in size during the 2005-2007 period, while most of the strong returns in the space had been made on investments from a few years earlier.

It's an age-old pattern of investors listening to their "consultants" and following each other in ever-increasing numbers/amounts into a market where returns have already peaked. Years later the same investors look back and question the whole asset class, cutting back their allocations just when it may be time to enter that market again. And analysts look at the returns of many large institutional investors (public and private pensions, endowments, and insurance firms) and wonder why their performance has been consistently poor.
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