Skip to main content
A combination of investment mechanics and the unpredictable nature of the economic and business environment means that attempts to time investments in private equity are highly unlikely to succeed, and will serve to undermine efforts to create a sustainable investment program.

In the current context of negative public market performance and elevated volatility, many investors might be tempted to take a tactical pause in their allocation to private equity (PE). While timing obviously can and does impact PE fund performance, it is a fool’s errand for even skilled investors to attempt to actively time investments in the asset class.
 
The impossibility of timing an investment in PE stems primarily from the interaction between its investment mechanics and the unpredictability of the economic and business environment.
 
This paper will explain in simple terms why our advice is to diversify across vintages by committing steadily over time.
 

INVESTMENT MECHANICS MAKE MARKET TIMING IMPRACTICAL

A vintage year – the year in which a PE fund first draws capital – effectively signals the start of a 10-plus-year process.1 Fund lifecycles are split into an investment period that typically lasts up to three to ve years and a subsequent harvesting period that can last as long as four to seven, or even longer with extensions (See Exhibit 1).

ex1-illustrative-timing

At least a small share of capital committed today to a primary PE fund may not be invested until 2027. So, an investor may be confident that they have a good read of today’s entry environment, but given the lag between committing capital and its deployment, and the flexibility that managers have as to when precisely they then deploy that capital, only some of an investor’s capital will be invested in something resembling the current environment. And as the COVID-19 pandemic has reminded us, circumstances can change quickly and dramatically.

The further out we attempt to forecast market conditions, the less likely we are to be accurate. Which means attempting to predict the conditions in which the fund will look to exit its investments is even more futile.

The mechanics of the PE model therefore mean that trying to cherry pick vintage years would require exceptional market foresight and macro timing. However, it should be noted that the latitude granted to managers to time investment decisions – both in terms of entries and exits – has been a meaningful contributor to returns, and may help mitigate against adverse performance in more challenging environments.2

BUY WHEN THERE’S BLOOD IN THE STREETS

The performance of PE funds over more than two decades reinforces the idea that pausing allocations in adverse public markets and/or during economic downturns would be a bad idea (See Exhibit 2). As Baron Nathan Rothschild once famously said, “Buy when there’s blood in the streets, even if the blood is your own.”

Exhibit 2: U.S. PE buyout fund vintage returns have strengthened in recessionary periods

Having just argued that you cannot time the PE market, it may seem odd to connect historical market cycles to performance. History is not circular and there is no guarantee that buyout fund returns will again improve during a market downturn – though there are many reasons to expect these funds to find value in a more favorable acquisition environment and benefit from a medium-term economic recovery. The more important point is that there is no compelling argument to be found in the data to not invest in PE funds because of an economic downturn.

Exhibit 3 illustrates and compares the hypothetical investment outcomes of committing capital to U.S. buyout funds only during bull markets – defined as calendar years in which the S&P 500 was up – or bear markets. Putting aside the impracticality of such an approach – which would require exceptional foresight and lead to uneven allocations that would create an unsustainable private equity program – the data show that the pooled IRR was higher for bear market vintages, while the TVPI was slightly higher for bull market ones.3

Exhibit 3: Difficult to argue that investing in only bull or bear markets is advantageous

The discrepancy between IRR and TVPI principally reflects a complicated mix of entry and exit timing and investment holding periods that form part of the private equity valuation process. Fundamentally, the only sensible conclusion to draw is that the difference in performance is insignificant.

While committing to buyout funds during a downturn has historically produced better returns than allocating to the vintages that directly preceded that decline (as Exhibit 2 shows), committing to vintages when stocks are rising does not necessarily produce weaker outcomes. For example, the 2009 to 2014 and 2016 to 2017 bull market vintage groups have so far produced pooled TVPIs of 2.05x and 1.91x, respectively.4

CONSISTENT COMMITMENT TO A DIVERSIFIED PE PORTFOLIO

Investors can help mitigate the impact of vintage performance volatility by allocating across multiple vintages and selecting high-quality investment managers. Manager selection is far more important than vintage selection in PE and has the added virtue of being a feasible exercise.5

Furthermore, a steady allocation pace across vintages adds critical diversification, helping to mitigate risk in a similar fashion to dollar-cost averaging, and allows an investor to build out a systematic PE program that eventually becomes self-funding by producing distributions they can reinvest. Skipping a vintage can make maintaining allocation targets difficult by disrupting this virtuous circle of distribution and reinvestment.

Timing the markets in the context of performing fundamental analysis on individual, liquid stocks is difficult enough. Given the nature of PE fund investing, a vintage selection approach that attempts to predict both market conditions and the performance of specific strategies far into the future has a slim chance of consistent success. This underscores the basic need to construct PE allocations that are diversified across as many dimensions as your resources can sustain, including by manager, strategy, geography, and vintage.

Was this article helpful?
YesNo

END NOTES

(1) Source: DVS Group, “The Ultimate Guide to Private Equity,” as of August 19, 2022.
(2) Source: Brown, Gregory W. and Harris, Robert S. and Hu, Wendy and Jenkinson, Tim and Kaplan, Steven Neil and Robinson, David T., “Can Investors Time Their Exposure to Private Equity?”, January 22, 2020.
(3) Source: PitchBook, as of July 28, 2022.
(4) Source: PitchBook, as of July 28, 2022.
(5) Source: McKinsey, “Private markets 2020: A new decade for private markets,” February 2020.


IMPORTANT INFORMATION — DISCLAIMER

The confidential material herein has been provided to you for informational purposes only by Institutional Capital Network, Inc. and its affiliates (together “iCapital”). This material is confidential and may not be reproduced or distributed to any person other than the intended recipient.

This material is provided for informational purposes only and is not intended as, and may not be relied on in any manner as legal, tax or investment advice, a recommendation, or as an offer to sell, a solicitation of an offer to purchase or a recommendation of any interest in any fund or security offered by iCapital. You should consult your personal accounting, tax and legal advisors to understand the implications of any investment specific to your personal financial situation. This material does not intend to address the financial objectives, situation or specific needs of any individual investor. Alternative investments are complex, speculative investment vehicles and are not suitable for all investors.

This presentation contains forward looking statements. Forward looking statements include, but are not limited to assumptions, estimates, projections, opinions, models and hypothetical performance analysis. Forward looking statements involve significant elements of subjective judgments and analyses and changes thereto and/or consideration of different or additional factors could have a material impact on the results indicated. Due to various risks and uncertainties, actual results may vary materially from the results contained herein. The forecasts provided are based upon iCapital’s opinion of the market unless otherwise noted, as of the date indicated and are subject to change, dependent on future changes in the market. Any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets is not necessarily indicative of the future or likely performance. iCapital makes no representation as to the accuracy or completeness of this material and accepts no liability for losses arising from the use of the material presented. No representation or warranty is made by iCapital as to the reasonableness or completeness of such forward looking statements or to any other financial information contained herein.

The manner of circulation and distribution of this document may be restricted by law or regulation in certain countries, including the U.S. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, including the U.S., where such distribution, publication, availability or use would be contrary to law or regulation or which would subject iCapital to any registration or licensing requirement within such jurisdiction not currently met within such jurisdiction. Persons into whose possession this document may come are required to inform themselves of, and to observe, such restrictions. It is the responsibility of the recipient of this document to comply with all relevant laws and regulations. This material is confidential, is the property of iCapital and may not be shared without the written permission of iCapital. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of iCapital.

Securities may be offered through iCapital Securities, LLC, a registered broker dealer, member of FINRA and SIPC and subsidiary of Institutional Capital Network, Inc. (d/b/a iCapital). iCapital Advisors, LLC, a subsidiary of Institutional Capital Network, Inc (d/b/a iCapital), is an investment adviser registered with the U.S. Securities and Exchange Commission (“SEC”). These registrations and memberships in no way imply that the SEC, FINRA or SIPC have endorsed the entities, products or services discussed herein. iCapital and iCapital Network are registered trademarks of Institutional Capital Network, Inc. Additional information is available upon request.

© 2022 Institutional Capital Network, Inc. All Rights Reserved.

Back to Private Equity
Kimling Fink

Kimling Fink

Kimling is a Senior Vice President on the Investment Products and Research team at iCapital, focusing on private capital strategies across single and multi-manager product offerings. Previously, she was a Director, Investment Management at AT&T, with responsibility for the private capital portfolio within the company’s defined benefit pension plan. Kimling also held roles at Canterbury Consulting, StepStone Group, and Parish Capital Advisors. Kimling holds a BS in Business Administration (Finance and Marketing) from Villanova University and is a CFA charterholder.

Richard Wells

Richard Wells

Richard is a Vice President on the Investment Products and Research team at iCapital, managing research content production for the team. He joined iCapital from HarbourVest Partners, a global private markets investment firm, where he was Senior Writer, and before that he worked as a Research Editor at the Financial Times. Richard received a BA in Politics from the University of Nottingham, and an MA in Chinese Studies from the School of Oriental and African Studies, London.