Key Takeaways
- • Andrea Auerbach, Cambridge Associates' global head of private investments, told Bloomberg Television on October 3, 2019 that the opportunity for private equity to outperform public market indices will be maintained for the foreseeable future.
- • Auerbach cited private equity returns of roughly 13% annualized over 25 years versus about 9% for the S&P 500, attributing the outperformance to managers acquiring control of companies and unlocking value.
- • Auerbach said dispersion of returns around the 13% figure is enormous, underscoring the importance of manager selection.
- • Auerbach flagged internal rate of return (IRR) as a metric that can be inflated through early exits and commitment facilities, and said Cambridge Associates evaluates managers on value creation rather than leverage-driven IRR boosts.
- • Average private equity leverage is around six times debt-to-EBIT, versus roughly three times for public market indices, according to Auerbach.
Summary
Andrea Auerbach, Cambridge Associates' global head of private investments, discussed private equity performance and valuation practices in an interview on Bloomberg Television on October 3, 2019, with Hema Parmar, Caroline Hyde and Scarlet Fu. Auerbach said that private equity returns of about 13% annualized over the past 25 years, compared with roughly 9% for the S&P 500, reflect the operational work of individual managers who acquire control of companies and unlock value. She argued that because private equity comprises thousands of managers raising funds of varying sizes, the outperformance opportunity versus public indices is likely to persist, and that the dispersion of returns around the 13% average is substantial.
On performance measurement, Auerbach said internal rate of return is a time-weighted and dollar-weighted metric that can be improved by earlier-than-expected exits and by the use of subscription or commitment facilities, which allow managers to borrow ahead of calling capital from investors. She said Cambridge Associates views the purpose of hiring a manager as acquiring and improving companies rather than using leverage to boost headline returns.
On leverage, Auerbach said low interest rates have enabled private equity buyers to borrow heavily against company values, contributing to purchase price multiples and average valuations of private equity-owned companies reaching all-time highs over the last couple of years. She said average leverage in private equity-owned companies is around six times debt-to-EBIT, compared with roughly three times for public market indices.
On valuation, Auerbach said private companies are typically valued using public comparables, private market comparables, discounted cash flow analysis and sum-of-the-parts analysis, with public comparables often serving as an anchor. She also noted that renewed political scrutiny of private equity, including comments from Senator Elizabeth Warren regarding highly leveraged companies, has emerged as a theme, and that growing public investor interest in active returns and greater transparency since the global financial crisis has increased attention on the asset class.
On performance measurement, Auerbach said internal rate of return is a time-weighted and dollar-weighted metric that can be improved by earlier-than-expected exits and by the use of subscription or commitment facilities, which allow managers to borrow ahead of calling capital from investors. She said Cambridge Associates views the purpose of hiring a manager as acquiring and improving companies rather than using leverage to boost headline returns.
On leverage, Auerbach said low interest rates have enabled private equity buyers to borrow heavily against company values, contributing to purchase price multiples and average valuations of private equity-owned companies reaching all-time highs over the last couple of years. She said average leverage in private equity-owned companies is around six times debt-to-EBIT, compared with roughly three times for public market indices.
On valuation, Auerbach said private companies are typically valued using public comparables, private market comparables, discounted cash flow analysis and sum-of-the-parts analysis, with public comparables often serving as an anchor. She also noted that renewed political scrutiny of private equity, including comments from Senator Elizabeth Warren regarding highly leveraged companies, has emerged as a theme, and that growing public investor interest in active returns and greater transparency since the global financial crisis has increased attention on the asset class.
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