Quantifying alpha

Kimberly Romaine
10 March 2011

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Alpha does indeed exist, and is strongest in private equity deals with active ownership; particularly when frequent interaction with - and even changing of - management is involved.

This was one of the findings by McKinsey Active Ownership research, presented today at the EVCA Investors' Forum in Geneva by Conor Kehoe, partner at McKinsey & Company.

The robust research put numbers behind what private equity executives have shouted about for years: that hands-on investing in companies can generate significant outperformance over public companies. The study suggests that the best deals - those involving the highest returns - involved management change; with 56% of top tercile exits involving new faces at the top. "Do it and do it quickly," Kehoe suggested.

The study further found a positive correlation between alpha and 'active ownership' for organic deals, with 'active ownership' involving not only changing management, but strong support from the private equity team throughout the holding period. This, Kehoe suggested, should involve the private equity backer having weekly meetings - or more - with the portfolio company CEO.

Alpha accounts for a quarter of the total IRR from large deals in Europe, or up to half when leveraged, according to the study. It found that an IRR of 41% would, on average, be comprised of eight percentage points from sector growth, 10 from alpha and 23 from leverage (on both sector and alpha).

The study was based on 102 realised European deals acquired between 1995 and 2005, with a bias towards larger buyouts.