Monday, February 28, 2011
Returns on Private Equity and Venture Capital Funds in the Third Quarter of 2010 Sharply Improved over the Prior Quarter
Both Asset Classes Extended Streak of Positive Returns to Six Consecutive Quarters
Strong public market performance and a gradually improving economy helped improve the results generated by private equity and venture capital funds in the quarter ending September 30, 2010. Each alternative asset class earned its sixth consecutive quarter of positive returns and significantly outperformed its respective prior-quarter results, breaking a short streak of declining positive returns in each category (four consecutive quarters for private equity and two for venture capital). Private equity outperformed venture capital during the same period, while both lagged public market returns – the latter a reversal from the second quarter of 2010, when both alternative asset classes produced better returns than the major public market indices, said Cambridge Associates LLC, a provider of independent research and investment advice to institutional investors and private clients. Private equity and venture capital funds continued to outperform the public markets over the long term.
Cambridge Associates publishes a quarterly commentary on the performance of private equity and venture capital as measured by the Cambridge Associates LLC U.S. Private Equity Index® and the Cambridge Associates LLC U.S. Venture Capital Index®. The indexes represent the majority of the institutional capital raised by private equity partnerships between 1986 and 2010 and venture capital partnerships between 1981 and 2010.
Improving Exits, Deal Activity, and Leverage Aided Third-Quarter Results
Private equity funds earned a 5.1% return for the third quarter of 2010, up from 1.6% in the prior quarter. Venture capital returned 3.7% versus 0.4% for the same periods. Both fund classes benefited from a resurgence in mergers and acquisitions (M&A) and initial public offerings (IPOs).
The increases brought the total returns for the first nine months of 2010 to 11.4% for private equity and 4.8% for venture capital. Private equity outperformed the key public market indices during the nine-month period; public index returns ranged from 3.9% for the S&P 500 to 9.1% for the Russell 2000 Composite. Venture capital, on the other hand, had a mixed performance during the same period versus the public markets, besting the NASDAQ Composite and S&P 500, but returning significantly less than the Russell 2000 Composite. The private equity and venture capital indices handily outperformed their public-market counterparts over the 15- and 20-year periods ending September 30, 2010. The following table provides comparative returns for the third quarter and longer periods for private equity and venture capital vis-à-vis four key public market indices. Returns for periods of one year and longer are annualized.
With the exception of the present quarter, the private equity benchmark outperformed U.S. public markets in all of the time periods provided in the table above. The venture capital index’s results were mixed, except over the long term, where, as noted, they eclipsed public market results. The spread between the private equity and venture capital ten-year returns continued to widen in the third quarter, moving to 12.7% from 11.5% as of the second quarter.
Private Equity Fund Insights
By third-quarter’s end, capital distributions for 2010 were nearly triple all of 2009
Fund managers in the U.S. private equity index called and distributed more capital in the third quarter than they did in the second. Limited partners (LPs) contributed just over $20 billion for the quarter, a 5.2% increase, and received distributions of nearly $16.7 billion, a 28% increase over the previous quarter and the highest level of capital distributions in three years. Investors in funds launched in 2000, 2004, and 2006 collectively received roughly $9.1 billion or 54% of the capital distributed during the period.
By the end of the third quarter, fund managers had already distributed to their LPs almost three times as much capital as they did in all of 2009.
“For the third quarter, contributions again outnumbered distributions, as they have for more than three years running,” said Andrea Auerbach, Managing Director and Head of U.S. Private Equity Research at Cambridge Associates. “We also saw the exit environment continue to improve, with realizations actually increasing faster than investments. In addition, credit availability during the third quarter continued on a path towards pre-recession levels.”
IT topped energy for best-performing key sector
During the third quarter, all eight meaningfully-sized sectors in the U.S. private equity index earned positive returns. Of these, the three largest by asset value – consumer, healthcare, and energy – comprised just over half of the index’s total value. Of the eight key sectors, IT performed best, returning 9.0% for the quarter, versus a close-second energy sector, which earned 8.7%. Software had the lowest return of the key sectors, 4.4%, but also represented the smallest weight (just 5.8%) in the PE index among the top eight.
Venture Capital Fund Insights
IPO and M&A environment improve
Venture capital performance and most industry fundamentals improved in the third quarter of 2010, with valuations for venture-backed companies rising for the fifth quarter in a row. Although there was a smaller number of IPO-exits during the period, average offering prices were higher than during the previous quarter. In addition, the number of mergers and acquisitions, the number of deals with disclosed values, and the announced deal values themselves all increased as compared to the prior quarter.
The top four vintages in the index remained constant, but the percentage weight of the largest vintage dropped significantly
The largest four vintage years by size – 2000, 2006, 2005, and 2004 – remained constant and accounted for 56.5% of the U.S. venture capital index’s value. However, the percentage represented by the largest vintage, 2000, was 19.6%, down from nearly 24% one year earlier.
The venture funds raised in 1999 were the top performers of the nine vintage years that represented at least 5% of the index’s value, returning 7.5%. Increased valuations for IT and higher values plus realizations from healthcare drove 1999’s results. Of the nine largest vintages, 2001 and 2006 were the worst performers for the quarter, each returning just 1.4%.
Software takes lead from IT for the first time in four quarters
Similar to the private equity benchmark, all of the meaningfully-sized sectors in the U.S. venture capital index produced positive returns for the quarter. The index continued to be highly concentrated by sector, with the top three – healthcare, IT, and software – comprising nearly 75% of its value. Software was the best performing of the top three sectors for the quarter, generating a 7.7% return. IT, which had been the top performing sector in the entire venture capital index for the previous three quarters, still came in second among the meaningfully-sized sectors, earning 7.3% for the quarter.
“Performance of venture capital was better in the third quarter, in part because the exit environment has gradually improved over the last year. The venture capital industry has now reached a more favorable risk-return balance, and the long-term outlook for the industry is being helped by other factors, including reduced fundraising and moderated pre-money valuations and investment levels,” said Theresa Sorrentino Hajer, Managing Director and Venture Capital Research Consultant at Cambridge Associates.