The whipsawing observed in listed markets over the course of 2020 made for some of the most eagerly anticipated year-end private markets valuations in recent memory. Readers of our COVID-19 & Market Updates will recall that we’ve been predicting for some time that Q4 2020 would be one of the best quarters for private markets in recent memory, with the caveat that it would also show the widest dispersion of returns between funds. We also posited that calendar year 2020 would show similar record levels of dispersion. It’s time to check our work and examine how those predictions fared.
Let’s start with the headline performance numbers for Q4 2020. Private equity strategies returned 16.3% over the course of Q4 2020, while private credit strategies returned 6.3%. Those returns are among the best single quarter returns in the last 20 years:
How about real assets? Much like private equity and private credit, real estate and infrastructure also fared very well relative to historical averages:
So, our prediction of Q4 being one of the strongest quarters in recent memory seems to hold, though admittedly it was not a particularly bold or uncommon prediction. What about our second prediction about increased dispersion at the fund level?
We’ve shown a version of the chart below in earlier market updates. Each dot represents the Q4 2020 return of fund in the respective strategy. We’ve overlayed quartiles on each strategy to get a sense of the summary distribution statistics.
A few things stick out to us:
- As you might expect, the dispersion of returns in Q4 2020 was higher among strategies with higher perceived risk. Origination credit and infrastructure had relatively narrow dispersion, while growth equity and venture capital experienced the most.
- The 3rd/4th quartile boundary was close to 0% for most strategies, implying there were still ~25% of funds that took a markdown in Q4. The notable exception to this rule was mega/large buyout, with a 3rd/4th quartile boundary closer to 6%.
- Larger buyout funds outpaced their smaller peers on a pooled and median basis in Q4, with a higher top quartile hurdle and a higher bottom quartile threshold – which also held true for prior quarters in 2020. Is this a case of larger buyout funds showing more sensitivity to short-term market movements, or is it perhaps indicative of a longer-term trend?
- We sifted through the top quartile performers to see if there were any common threads , but surprisingly, there weren’t any immediately obvious links among them. Funds of all sizes, regions, and sectors – even funds investing in hard hit sectors like hospitality – performed well in Q4.
What about on a calendar year basis?
For the full calendar year 2020, median returns for private equity funds were the highest since the turn of the millennium, at 18.6%. While downside (measured by the bottom quartile threshold) was consistent with recent years, the upside for top funds was a lot higher: managers would have needed to post a >40% (!) return for the year to be among the best performers. Those elements mean that dispersion of returns, measured by interquartile range, was the widest it’s been in the last 20 years, bucking a two-decade long trend of moderate declines in calendar year return dispersion:
In our 2021 Market Overview, we openly wondered whether funds with the largest markdowns would have larger (or smaller) rebounds in subsequent quarters. The early evidence suggested there was little relationship between initial markdowns and go-forward performance, which was consistent with the industry’s experience in the aftermath of the GFC. We’ve now updated our initial analysis to include data from Q4 2020:
Notice anything (other than a Rorschach-looking smattering of dots)? Maybe a very faint, negative sloping trend? If you drew trend lines for each strategy you would not see a statistically significant relationship. Perhaps looking at summary level clusters will yield more meaningful insights:
The table above gives the probability that a private equity fund would fall into a specific return quartile based on its Q1 2020 quartile (e.g., the top left corner implies that 22% of funds with a top quartile Q1 2020 return also had a top quartile return in Q2 through Q4). A few loose “corner” relationships stand out in this view. Funds that generated a fourth quartile return in Q1 2020 (i.e. a larger markdown) tended to have a slightly higher probability of first quartile performance over the subsequent quarters in 2020 and a slightly lower probability of fourth quartile performance. An equally colorful relationship can be found in the top corners of our heat map. In other words, funds that had a top quartile Q1 2020 return were more likely to have a fourth quartile return in subsequent quarters and less likely to have a top (or second) quartile return. In short: There is some evidence that funds that had particularly large (or, in the opposite scenario, small) markdowns in Q1 2020 had better (or worse) experiences in Q2 – Q4 2020.
Astute readers may wonder whether those trends are partially a function of grouping venture capital, growth equity funds, and buyout funds together. A good question – and one that we anticipated. We can confirm that these results are robust at the strategy level, though the relationships are mildly stronger for buyout than they are for venture capital and growth equity.
We’ve admittedly just thrown a lot at you (how many times can we possibly use the word quartile in one paper?), but what does this all mean for LPs? After a period of tightening return dispersion between managers, we are seeing some early evidence that the dispersion between the best managers and average managers is starting to widen, and we expect that widening to continue into 2021. We’re also seeing managers touting what a great 2020 they had (while conveniently ignoring that many of their peers had a similarly great year). For LPs, these dynamics place a renewed recognition of the need for robust data and benchmarking tools to evaluate managers, as well as on the importance of manager selection.
This presentation is not an offer to sell, or a solicitation of any offer to buy, any security or to enter into any agreement with Hamilton Lane or any of its affiliates. Any such offering will be made only at your request. We do not intend that any public offering will be made by us at any time with respect to any potential transaction discussed in this presentation. Any offering or potential transaction will be made pursuant to separate documentation negotiated between us, which will supersede entirely the information contained herein.
Any tables, graphs or charts relating to past performance included in this presentation are intended only to illustrate the performance of the indices, composites, specific accounts or funds referred to for the historical periods shown. Such tables, graphs and charts are not intended to predict future performance and should not be used as the basis for an investment decision.
The information herein is not intended to provide, and should not be relied upon for, accounting, legal or tax advice, or investment recommendations. You should consult your accounting, legal, tax or other advisors about the matters discussed herein.
As of June 17, 2021