Thursday, March 8, 2012

U.S. Private Equity and Venture Capital Funds Posted a Loss in Q3 2011


Ending a String of Nine Consecutive Quarters of Positive Returns

Both Asset Classes Outperformed the Public Markets During the Quarter, with Venture Capital Besting Private Equity for the Second Consecutive Quarter, According to Cambridge Associates

Returns on investments in U.S. private equity and venture capital funds were negative for the three-month period ending September 30, 2011, marking the end of a series of nine consecutive quarters of positive performance for both alternative asset classes. The downward turn was due in part to the escalating debt crisis in Europe, which helped cause an even sharper drop in the public markets during the period, according to Cambridge Associates LLC.

Venture capital outperformed private equity for the second quarter in a row, falling 0.7% versus a drop of 4.3% for private equity in the quarter, according to Cambridge Associates LLC U.S. Venture Capital Index® and Cambridge Associates LLC U.S. Private Equity Index®. By comparison, the NASDAQ Composite fell 12.9% and the S&P 500 dropped 13.9% during the same period.

The private equity benchmark bested all of the public market indices tracking large and small public companies in every time horizon listed above; the venture capital benchmark did almost as well, outperforming the public markets in all but the ten-year period ending on September 30, 2011. The venture capital index’s ten-year return improved again in the third quarter, and now has risen almost 7% from its nadir of -4.6%, hit during the third quarter of 2010.

The spread between the ten-year returns for private equity and venture capital has continued to narrow, closing to 8.9% from 10.1% in the previous quarter. The spread was 12.7% in the third quarter of 2010.

“While M&A activity was stable and healthy during the third quarter, IPOs fell significantly. The low issuance of IPOs combined with a great deal of market volatility led to crimped valuations and dragged down the venture capital index’s returns. However, IPOs and the markets rebounded in last year’s final quarter, which should improve the VC index’s fourth-quarter returns,” said Theresa Sorrentino Hajer, Managing Director and Venture Capital Research Consultant at Cambridge Associates.

Capital Distributions Down for Both Alternative Asset Classes in the Quarter

Private equity fund managers distributed $18 billion to their limited partners (LPs) during the third quarter, a drop of 22.4% in distributions from the previous quarter. The decrease was the largest in percentage terms since the first quarter of 2009. The same fund managers called $17.9 billion from the LPs during the period, a 22.8% increase over the prior quarter. Despite the drop in distributions, this was the fourth consecutive quarter in which distributions outpaced contributions for private equity LPs.

Managers of venture capital funds returned less capital than they called during the third quarter: $3.6 billion versus $3.8 billion, respectively. The drop in distributions represented a 19% decrease from the second quarter and was the first time in four quarters that fund managers returned less capital than they called.

Software Posted Top Returns among Largest Sectors in Both Benchmarks

Among the eight sectors comprising at least 5% of the private equity index’s value, only two posted positive returns for the quarter. Software led the way with a 2.0% return while consumer, representing slightly more than one-fifth of the index, returned just under half that amount, 0.9%. Four sectors in the private equity benchmark – consumer, energy, healthcare, and financial services – comprised nearly 60% of the index’s value and, collectively, returned -2.8% for the quarter on a dollar-weighted basis.

“The positive contributions of the consumer and software sectors were unfortunately overwhelmed by the negative returns of the other six major sectors represented in the private equity index this quarter. Of note, the consumer sector is the largest contributor to the index and the vintage years driving its performance are 2004, 2006, and 2007, the latter two being squarely in the crosshairs of the last private equity market peak. That the sector kept its head above water this quarter is heartening. And managers continue to see a lot of opportunity in the space, as consumer-focused companies also attracted the most capital in the quarter, about 22%,” said Andrea Auerbach, Managing Director and Head of Private Investment Research at Cambridge Associates.

Software was also the top performing large sector in the venture capital index, returning 4.7% while comprising 15.3% of the value of the index. Information technology (IT), the largest sector in the index at 34.8% of the benchmark’s value, was the only other significantly-sized sector in the benchmark with a positive return for the period; it earned 2.8%. IT, healthcare, and software accounted for more than 75% of the market value of the venture capital index.

All but Two Vintage Years Since 1995 Saw Negative Returns for the Quarter in PE Index

Every vintage year in the private equity index showed a negative return for the quarter except 1997 and 2010, and neither of those vintages represented even 1% of the index. The 2008 funds were the best performing among the six meaningfully-sized vintage years, returning -0.7%. The worst-performing funds were from vintage year 2005, which fell 6.4%. The drop was due in part to the impact of falling energy prices on their energy-sector portfolio companies.

In the venture capital index, the best performing vintage year among the nine top-sized vintages for the quarter was 2007, which returned 3.8%. Only two other of the large vintages, 2008 and 2005, had positive returns: 1.4% and 1.0%, respectively.

Consumer and Energy Companies Attracted the Most Private Equity Capital, while IT and Healthcare Garnered the Most Investments from Venture Capital Fund Managers

Private equity fund managers funneled over two-thirds of their investment dollars into five sectors during the third quarter: consumer, energy, healthcare, manufacturing, and software. Consumer and energy were the biggest winners, together attracting almost 40% of the capital invested.

In the venture capital index, the sectors attracting the most investment dollars were IT and healthcare; together, companies in these sectors captured 61% of the total capital invested during the quarter.

A copy of Cambridge Associates’ commentary on the third-quarter performance of its U.S. private equity and venture capital benchmarks is available at


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