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Investment and Performance Review of

Date: September 14, 2023

SSRN Number 4534048 Posted

Jeffrey C. Hooke
Johns Hopkins Carey Business School

Research Assistants: Yefan Zong, Johns Hopkins Carey Business School, and
Dee Velazquez, Johns Hopkins University
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Executive Summary

The Leonard Green private equity fund family is emblematic of the curiosities surrounding the PE industry
and laid out in this report. Green Equity VI fund ($6.3 billion, 2012 vintage) has yet to sell 47% of the
stated value of its investments, i.e., 11 years after its start up. The question then becomes, if the fund’s
underlying investments are so valuable, how come no one wants to buy them? Additionally, despite a
20% stock market downturn in 2022, the fund’s claimed 14% IRR remained static from 2021 to 2022, so
the fund’s 2022 mark-to-markets defies economic sense.

Similar issues beset the Green follow-up fund ($10 billion in 2017). Interestingly, the Green fund family
had no problems in raising two subsequent funds ($12 billion in 2020 and $10 billion in 2022), thus
posing thought-provoking inquiries into the rigor of the investor due diligence process.

This report highlights 19 of the top 25 US PE-LBO families, and it shows an industry adept at deploying
money quickly for investments yet needing at least a dozen years to sell them. The median TVPI and PME
statistics for the sample were 1.9 and 1.2, respectively, using the data available at April 2023. These
numbers suggest mildly positive performance, compared to public equities; however, the performance
data ignored the 2022 stock market decline, which should have negatively affected private corporate
values and correspondingly those two statistics. Public markets’ IRR was -19%, yet PE fell just -1%, if you
believe PE mark to markets.

The likelihood of survivorship bias exists in the data, as the top 25 PE families have changed over the last
15 years, with a few PE families moving in and out of the list. Those that moved out likely had lower
than average performance. Furthermore, we were unable to obtain good PME performance data on six
of the top 25 funds, and it seems reasonable to assume that the worse performing fund families had an
incentive to underreport data.

Adapting a risk-adjusted premium to the PME data, which most industry investors do not do, means
adding the effects of high leverage, fund credit lines, illiquidity, and opaque information to the investors’
required return. A 3-4% annual IRR premium, sometimes proposed by outside industry researchers,
deflates the median PME statistic to a number that is likely below 1.0, even before the needed
adjustment for the stock market drop.
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Report Description

The report reviews selected investment and performance statistics of 19 of the top 25 PE-LBO fund
families in terms of investor commitments. Statistics for certain funds were unavailable or incomplete,
and this fact might imply that the missing funds performed worse than average. A prominent PE data
services firm supplied the raw information.

Table 1

The report examined funds with vintage years from 2005 to 2020. A ‘vintage year’ is the year in which a
fund began operations. We considered funds with a vintage year before 2005 (i.e., 18 years) as too
dated for a 2023 study. 2021 – 2023 vintages were too young for inclusion.
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Table 2

Years to Invest, Years to Sell

The median number years it took for the typical fund to invest 60% of its commitments was 2.3 years.
The average for 60% investment was 2.5 years. 60% is important, since, once that level is reached, a
fund family can start a new fund. Several funds invested 60% of commitments in less than two (2.0)
years.

The median years to invest 100% of a fund’s commitments was 4.3 years. The average was also 4.3
years.
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Table 3

For those funds that had sold, for cash, over 90% of their respective TVPI (see below for TVPI definition)
the youngest fund was vintage 2012 (i.e., 11 years). Only 28 funds out of the 73 total funds achieved the
90% threshold. We observed multiple funds that were 8-12 years old, yet not meeting the 90%
threshold.

Table 4
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Years to Start Follow-up Fund

The median number of years between a fund and a subsequent “follow-up” fund was 4.0. The average
was also 4.0.

Investors thus committed to new funds without definitive knowledge of the cash return of the
immediately prior fund, since selling 90% of investments from an existing required a decade or more.

Under current practice, limited partner investors (and their investment consultants) do not perform
independent valuations of the underlying unsold PE-LBO investments of prior funds in order to confirm
the PE managers’ mark-to-markets. Thus, the investors commit to new funds, based on the PE-LBO fund
managers’ mark-to markets of prior funds. On the surface, this lack of investor due diligence might
indicate a violation of the “prudent man rule,” but neither a regulator agency nor a class action law firm
has pursued this notion. In any case, recent studies have shown no persistence in the PE-LBO fund
industry’s performance from one prior fund to another. Nonetheless, the practice of recommending
investment in a new fund, based on the fund family’s prior claimed historical results, continues to this
day.
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PME Results

The public market equivalent (PME) is a collection of performance measures developed to assess private
equity funds and to overcome the limitations of the internal rate of return and TVPI measurements. The
PME measures the return from deploying a private equity fund's cash flows into a stock market index.
Here, we use the Kaplan Schoar PME with the S&P 500 index. A PME larger than 1.0 indicates a fund’s
return was higher than the S&P 500 index, often considered a mirror of the broad stock market. For
example, a 1.2 PME suggests that the fund’s return over time produced an amount of cash (plus unsold
investment value) at the end of the measurement period of 20% over an equivalent stock market return.
The PME assumes the valuation of unsold deals is accurate.

The database allowed for the calculation of the S&P 500 KS PME statistic for 60 out of 73 funds, and 13
funds were excluded due to missing data. Of the many fund marketing documents reviewed by the
author, none contained a PME statistic, preferring IRR or TVPI.

Table 5

The median PME for the 60 eligible funds was 1.23. The average was 1.27. As noted later, the PME
measurements as of the observed dates appear to ignore the stock market decline in 2022 (and its likely
applicability to private investments) for those funds not mostly liquidated. Assuming adjusted mark-to-
markets suggested by a 20% stock market decline, the median PME might be 1.00.
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Table 6

Some academics and certain PE-LBO fund industry observers have suggested that the higher leverage of
a PE-LBO fund’s underlying investments (plus fund-level credit lines), relative to their publicly traded
counterparts, should result in PE-LBO fund investors requiring a higher return than public stocks (i.e., a
risk-adjusted return). Furthermore, the illiquidity and opaque information endured by limited partner
(LP) investors also suggests a higher required rate of return than the liquid, information-heavy stock
market. If the PME equality measure is boosted from 1.00 to 1.30, for example, 25 out of 60 eligible
funds exceeded this number.

For 2017 (and older) vintage funds, the median and average PME’s were 1.23 and 1.27, respectively.

For 90%+ liquidated funds for which a PME was calculable, the average PME was 1.27. Those funds were
12 years or older.

Table 7
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Using a minimum of three data points, the fund family with the lowest average PME over multiple funds
(2005-2020) was Blackstone, which has just raised a new $20 billion fund. The fund family with the
highest average PME was Clayton Dubilier & Rice (CDR). However, note that 57% of CDR Fund X (2017
vintage)’s TVPI and 43% of CDR IX (2013)’s TVPI are unsold, and thus heavily reliant on mark-to-markets.

TVPI Results

The ‘Total Value to Paid In” (TVPI) statistic is the ratio of (i) the current value of remaining investments
within a fund, plus the total value of all cash distributions to date, relative to the total amount of capital
paid into the fund to date. Thus, if a fund has $500 million of cash paid out to date, and a remaining
investment value of $800 million, then the numerator is $1.3 billion (500 + 800) in the ratio. If the cash
paid in by the investors is $1 billion, then the ratio is 1.3 (1.3 billion / 1.0 billion = 1.2). A ratio of 1.3
indicates the investors received 30% more money than they put in, although the ratio does not consider
the time value of money, or whether the investor could have done better in the public stock market.

The median TVPI for the total sample was 1.9. The average was 2.0. This statistic assumes the fund
managers’ “mark-to-markets” for unsold PE-LBO investments were accurate.

For funds with a vintage year of 2017 (or older), i.e., six years or older, the median TVPI was 2.0. The
average was 2.1.

Table 8
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As noted, the funds needed over 11 years to realize a 90%+ cash TVPI.

Internal Rate of Return (IRR)

Except for a handful of funds, the forecast internal rate of returns (IRRs) for the non-90%-liquidated-
funds did not fall significantly over the June 2022 – December 2022 reporting periods. The stock market
recorded a sharp decline in 2022’s first nine months. The lack of IRR changes suggests the PE-LBO
industry’s mark-to-markets for unsold deals did not change much, despite the public stock market drop.

Indeed, according to data from the California, New Jersey and Maryland state pension funds, the private
equity industry showed a -2% to 0 % return in 2022, even as the S&P 500 return was minus 20%. The PE
industry’s lobbying group, the American Investment Council, reported a similar pattern of returns. The
PE-LBO sector is roughly two-thirds of the PE industry.

Table 9
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PE-LBO funds’ returns showed a similar pattern over the last two stock market downturns.

In theory, private corporate values should correlate well with public corporate values. Moreover, in
theory, more-leveraged private values should fall to a greater degree than less- leveraged public
corporate values in a downturn. This inconsistency between (a) accepted theory; and (b) mark-to-
market practice did not deter new fundraising in the PE-LBO sector, nor did it prompt regulatory review.
Fund family management fees and new fund marketing documents place weight on these private
values.

As of December 2022 reporting, KKR Fund XII ($13 billion, 2016 vintage) indicated a 19% IRR, yet its
largest investment, Envision Healthcare ($3.5 billion in equity), filed for bankruptcy in May 2023, just a
few months later.

Accurate private investment reporting was highlighted recently with Icahn Enterprises stock dropping as
much as 60% in 2023 on concerns about the accuracy of its mark-to-markets.

The IRRs in the accompanying Exhibit A are not adjusted for the general partner’s (i.e., PE fund
manager’s) use of PE credit lines at the fund level. Neither are the PME calculations. Almost all the larger
fund families utilize such credit lines to try to enhance debt leverage, and thus returns, should the
underlying portfolio investments increase in value.

About one-third of the new funds have higher IRRs than the prior fund.

Unsold Investments and TVPI

Funds 6-10 years old (2013-2017 vintage years) play an important role in the sale of subsequent 2018-
2023 vintage funds, since these earlier vintages are somewhat mature, and investors and their
consultants reason that follow up funds can duplicate earlier performance. For 6–10-year-old funds, the
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median percentage of unsold TVPI was 46%. As noted, this percentage of TVPI was thus marked-to-
market by the fund managers, since the underlying investments are not publicly traded.

Table 10

Leonard Green, Golder Thoma, New Mountain, and Vista Equity Partners had the highest percent of
unsold TVPI for their 6–10-year-old funds. This fact did not deter these PE fund managers from starting
new funds over the last few years.

Summary

This report reviewed selected investment and performance statistics of 19 of the top 25 PE-LBO fund
families.