Skill and Luck in Private Equity Performance

By Arthur G. Korteweg Morten Sorensen
April2014| Working Paper No. 3096

We evaluate the performance of private equity (PE) funds, using a variance decomposition model to separate skill from luck. We find a large amount of long-term persistence, and skilled PE firms outperform by 7% to 8% annually. But this performance is noisy, with a large amount of luck, so top-quartile performance does not necessarily imply top-quartile skills, making it difficult for investors (LPs) to identify skilled PE firms. Buyout (BO) firms show the largest skill differences, implying the greatest long-term persistence. Venture capital (VC) performance is the most noisy, making good VC firms hardest to identify, and implying the smallest amount of investable persistence.

Keywords
Persistence
skill
private equity
venture capital
learning