Practical Applications of Private Equity Valuations and Public Equity Performance

Practical Applications Summary

In Private Equity Valuations and Public Equity Performance from the Summer 2019 issue of The Journal of Alternative Investments, authors Megan Czasonis (of State Street Associates), Mark Kritzman (of Windham Capital Management and the MIT Sloan School of Management), and David Turkington (also of State Street Associates) demonstrate that private equity (PE) managers introduce positive bias into their quarterly investment valuations. Managers tend to overprice their shares by overstating how well their investments performed during the quarter. These optimistically high valuations are induced by public market gains that happen after quarter end; PE managers raise their share valuations when the public equity market goes up during the reporting delay after quarter end—but they do not lower valuations if the market declines. This uneven response to market gains and losses after quarter-end means that valuations are often unrealistically high. The underlying driver confirmation bias, the tendency of managers to only cite evidence that shows their investments did well. But since managers tend not to do this in the fourth quarter, when investment valuations are independently audited, PE funds appear to gain more in Q1 through Q3 than in Q4. This introduces artificial volatility in performance over the year and has serious implications for investors and advisors.