Canterbury frequently receives client questions about the risk/return profile of private capital sub-strategies. While there are many ways to approach the question, this blog post uses the range of returns between top and bottom quartile funds as well as standard deviation to provide context.
Canterbury utilized data as of the most recent reporting quarter with internal rate of return (IRR) as of November 16, 2020. The total data set is 3,368 funds raised between 2002 and 2017, as performance data for funds raised in 2018 or later is not yet as meaningful.
Private capital managers update valuations for portfolio companies on a quarterly basis, relative to public market investments that are constantly marked to market. This infrequent performance data means that traditional methodologies to calculate volatility and risk-adjusted return, most notably the Sharpe Ratio, are less meaningful.
The graph below shows the range between the first and fourth quartile and the standard deviation for each private capital sub-strategy that Canterbury recommends. The range is calculated as the difference between the threshold for first quartile and fourth quartile. For example, fourth quartile venture funds were a net IRR of 0.8% or lower, while first quartile venture funds were a net IRR of 19.9% or higher for a range of 19.1%.
Exhibit A. Source: PitchBook as of November 16, 2020.
The dispersion of returns only tells part of the overall story. The table below provides the numbers behind the data, ordered by median net IRR.
Exhibit B. Source: PitchBook as of November 16, 2020.
In aggregate, this analysis speaks to the importance of diversification within private capital portfolios. Investors with a lower risk appetite can allocate more capital to credit, distressed, and secondaries strategies, while those seeking a higher risk/return can instead increase exposure to venture and growth.
This article was written by Erick Podwill, Vice President, Investment Research. As a member of Canterbury’s Research Group, Mr. Podwill is responsible for sourcing, evaluating, and monitoring private capital managers. He serves as chair of Canterbury’s Private Equity Manager Research Committee, and sits on the Capital Markets and Fixed Income Committees. Prior to joining Canterbury, Mr. Podwill was an associate at TorreyCove Capital Partners, LLC, where he performed due diligence on private capital managers, with an emphasis on the areas of growth equity and venture capital. Mr. Podwill double majored in finance and business administration at the University of San Diego, where he received a Bachelor of Business Administration.