Buyout funds: The Alpha factor

According to reseach carried out by the London Business School (LBS) and the French research company HAC, backed by the BVCA and data from fund-of-funds manager Pantheon, the alpha component contributed around 5% to buyout fund performance.

The study, which took data from 64 realised and unrealised buyout funds with a 19.6% average IRR, found that passive return accounts for around 1.42% of performance, with sector differential 6.01%, leverage 7.71% and alpha generating 4.47%. Pantheon's head of European primary investments, Helen Steers, says this research shows the ability of private equity funds to generate their own alpha, independently of leverage, exit timing and sector selection.

LBS and HAC highlight that alpha accounts for around 23% of average buyout fund returns, a substantial contributor to LP proceeds. The data supplied by Pantheon showed that buyout fund returns are not solely attributable to leverage, and debt clearly not the only driver of their success. The news may reassure some reluctant LPs, which believe the private equity industry is overly-reliant on leverage - currently in scarce supply - to generate returns.

That said, the study acknowledges that leverage's 7.71% contribution to the average IRR remains a significant factor in private equity returns, but notes that other factors are at play as well, and that high levels of leverage are not needed for buyout funds to produce significant returns. With unquote" data pointing to a rise in the number of all-equity deals taking place, some funds may be hoping to generate considerable alpha on their investments to make up for a lack of leverage in the current market.

The full report is available to download from the BVCA website, www.bvca.co.uk

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