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Dec. 9, 2015
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MEASURING RISK
New Metric Offers LPs a Way to Gauge the Risk and Volatility of Their Investments
BY MACK HERLYN AND MINN KIM,
BLOOMBERG DATA

For limited partners investing in private


equity, venture capital and other
alternative asset classes, measuring risk
is difficult. Simply finding a way to
measure it is a challenge. Most
institutional investors today benchmark
their portfolio returns against the public
market but use more informal methods to
evaluate risk.
Private equity research firm Peracs has
developed a novel method of assessing
value creation and the risk profile of
private equity portfolios. This approach
adds another dimension of analysis for
limited partners, offering insights into
their own investment patterns and how
their returns were achieved. For
example, the analysis can help LPs
select strategies by identifying which
areas within the portfolio provide the
steadiest returns. This allows investors to
actively manage their risk.
This new risk metric, the so-called the
Peracs Risk Coefficient, is a measure of
the dispersion of results for a given set of
investments. Using private equity returns
data compiled by Bloomberg,
researchers at Frankfurt-based Peracs
and Bloomberg analysts from the private
equity data team applied the technique to
the buyout portfolios of two large public
pensions, as well as to different vintages
of buyout and venture funds.
The results showed that one pension
fund's investments were markedly more
consistent (i.e., less risky) than the
other's. Another analysis demonstrated
that venture capital investments have
higher risk profiles than those of buyouts.

Two Major Pension Funds Have Very Different Risk Proiles

Comparing Pensions
We began with the buyout portfolio of
Pennsylvania Public School
Employees Retirement System, first
analyzing just that portfolio and then
comparing its risk profile to that of the
universe of all buyout funds.
Between 1998 and 2010, Penn PSERS
had a remarkably steady Peracs risk
coefficient, ranging between 0.27 in 1998
to 0.4 in 2010.
A risk coefficient of 0 indicates perfect
equality or in other words, that all fund
managers provided the same levels of
return. A risk coefficient of 1 indicates
perfect inequality one fund manager is
responsible for all the returns. (In more

technical terms, the Peracs Risk


Coefficient is a refinement of the Gini
coefficient, a macroeconomic indicator of
equality, that measures the distribution of
relative performance across a set of
investments. The risk coefficient is the
numerical expression of the area
between a line of perfect equality and the
risk curve of a portfolio.)
By contrast, North Carolina
Retirement Systems portfolio shows
much greater volatility. In 2001, NCRS
had a lower risk coefficient for its buyout
portfolio than Penn PSERS, but three
years later the risk coefficient for NCRSs
funds not only exceeded that of Penn
PSERS's, but it was 20 percent higher
than that of all buyout funds. This
indicates that NCRS was receiving a

Continued on next page

Dec. 9, 2015

Bloomberg Brief

Private Equity

MEASURING RISK
Continued from previous page...

large proportion of its total return from a


Venture Funds Display a High Risk Profile
relatively smaller number of funds.
By the 2010 vintage, however, NCRSs
risk coefficient had fallen to 0.39, lower
than that of the buyout universe at 0.54,
suggesting the pension steered back
toward steady returns rather than hit-ormiss fund managers.
North Carolina sold some of its 2007
buyout holdings in the secondary market
and its 2007 vintage holdings are "neither
significant nor a diversified allocation,"
Brad Young, a spokesman for the
pension, said in an e-mail. He said the
pension does not list any 2004 buyout
holdings. The vintage dates in the
analysis are those assigned to the funds
in Bloomberg's private equity database.
The private markets manager at Penn
PSERS was not available to comment in
time for publication, according to a
spokeswoman for the pension.
While NCRS and Penn PSERS are
The variance in returns for vintage
Those are measurements within a
currently invested in nine of the same
2001 venture funds raised a year after
portfolio. But the approach can also be
buyout funds, the two pensions have
air began to hiss out of the dotcom
used to compare the risk of a limited
very different risk profiles since 2001.
bubble is very large with a risk
partner's portfolio to investments more
NCRS's risk profile exceeded that for all
coefficient of nearly 1.0. Sampling the
broadly, such as funds of the same
buyout funds in 2004 and 2007, but was
risk measure every three years shows a
vintage and strategy.
lower for vintage years 2010 and 2013.
steady decline through 2010, when it was
We compared the risk coefficients for
Part of that may be explained by the
0.61.
the two pension funds' buyout portfolios
fact that it has a smaller portfolio than
The reduced variation can also be seen
to the coefficients for all buyout funds,
Penn PSERS (46 versus 112). The
in the best and worst internal rates of
sampling every three vintage years from
Pennsylvania pension's risk level may be
return for funds of each vintage year
1995 and 2010.
moderated by diversification.
sampled. The worst (and best)
Buyout funds in 1998 had a risk
(The sharp rise in risk coefficients for
performing fund in each vintage
coefficient of 0.64 while 2010 funds had
2013 buyout funds across the board
contributed to a considerable loss (or
a more moderate risk coefficient of 0.54.
probably reflects the nascent investment
gain) of capital resulting in each year's
In both vintage years, PSERS has much
stages of these funds. These funds are
risk profile.
lower risk profile, with coefficients of 0.27
likely to have made few realizations with
The conclusion: Venture capital funds
and 0.40, respectively. This suggests
many of them having yet to complete
remain highly risky. And that is worth
that Penn PSERSs general partners
their investing phases. At this early stage
bearing in mind at a time when limited
generated returns that were quite similar
in the fund lives, results naturally vary
partners are plowing more capital into the
to one another's, and Penn PSERSs
widely.)
asset class. In the last 12 months, limited
returns from its buyout portfolio are
partners have committed $4 billion to
spread more equally across its managers
venture funds. LPs have committed
Venture Has Higher Risks
than returns are across the universe of
$27.5 billion to buyout funds in that time.
all buyout funds.
With assistance from John E. Morris,
A final analysis of risk profiles on
Moreover, Penn PSERS's buyout
Bloomberg Brief
strategies across all funds raised
portfolio has consistently maintained a
between 2001 and 2010 highlighted risk
lower risk profile than the larger buyout
in venture capital.
universe.

This story was written by Bloomberg LP employees involved with data collection and was edited by the News Department. To
suggest ideas or provide feedback, contact the editor for this story: John E. Morris at jmorris89@bloomberg.net or 212-617-0628.
For more information about Bloomberg Briefs, go to www.bloombergbriefs.com.

2015 Bloomberg LP All rights reserved. Reprinted by permission.

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