EIF Staff Paper, "Development of a Rating Instrument for Private Equity Funds"

    Date: 16 December 2003

Private Equity (PE) has grown as an alternative asset class for institutional investors over the last decades. The dedicated vehicle for managing PE investments is the limited partnership, where investors share investments in a fund managed by expert intermediaries. The PE Market is marked by unique characteristics: Illiquidity, long-time horizons, and finite lifetime; opaqueness; lack of continuity and predictability; high risk and uncertainty.

There has been the cry for more transparency in order to advance PE to a mature asset class. Likewise, there is a high demand for improving current risk/performance monitoring and valuation standards. At the same time, investors and fund managers are reluctant to participate in this improvement process, because the transparency is deemed to allow gaining competitive advantages.

In collaboration with the European Investment Fund's Division of Risk Management and Monitoring and based on an analytically rigid exploratory research approach, a straightforward rating instrument is developed that allows investors to share opinions about expected performance and inherent risks of their fund investments. It is based on the concepts of quartile ranking and complements this relative valuation by the inclusion of absolute performance predictions. The developed monitoring and valuation tool proves to be self-explanatory, unambiguous, and simple to use without requiring that investors have to disclose their decision-making processes.

It therefore is judged to be an ideal method that is able to bridge the paradox of bringing transparency to LPs without overly disturbing the advantageous opaqueness of the market.

Dissertation written by former MBA student Clemens J. Troche, who EIF's Division for Risk Management and Monitoring helped to supervise in 2002/2003.


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