In the past one and half decades, private equity funds have shown great interest in the continent.
Investors raised more than Sh500 billion (2021), up from Sh288 billion (2007) for allocation to Africa, according to the Africa Private Equity and Venture Capital Association (AVCA).
Globally, the same story applies. Data from Bain & Capital shows that global private equity funds raised over Sh120 trillion in 2022. The big draw? Positive returns and diversification benefits over traditional stock and bond portfolios.
Research shows that private equity has annualised 11 percent returns over 21 years compared to 6.9 percent for the public markets. But does private equity beat the stock market?
Most likely, yes, but it is really hard to measure and comes with big caveats. Here's why.
First, private equity market returns are usually subjective (mostly because these investments are difficult to value as they are largely illiquid) and involve a high degree of discretion on the part of the general partners (GPs).
Possibly, GPs of mostly bottom-quartile funds may use this as a perfect incentive to distort reported valuations to hide bad performance from their limited partners (LPs), hoping to secure commitments to subsequent funds.
In contrast, public markets do not have this luxury, as valuations are pegged on transparent market prices.
Secondly, there's the metric comparison argument that seems not to fade away.
Returns in private equity are measured based on the internal rate of return, which is a measure based on actual cash distribution to investors rather than the current market values of the underlying assets.
On the other hand, returns on public market investments are broken up into separate intervals based on whether money was added or withdrawn.
Put differently, returns in the private market returns are money-weighted, while returns in public markets are time-weighted. The distinct difference in these valuation metrics means their respective outcomes are not truly comparable.
Lastly, there's the cheesy question (but still important) since most LPs are required to have a reserve of liquid assets to then fund their PE investments, why is this component not included in the overall private equity return calculations? Of course, this would certainly water down their juicy returns.
For ignorant people like me, this does not make sense since unused cash on public market funds is measured against the overall returns. Besides, there's the point that most private equity returns are not standardised.
Anyway, one thing is for certain: return metrics are unlikely to change anytime soon — in fact, they may get even murkier.
I take note that some Sh84 billion was raised by Africa-focussed funds categorised as "continuation funds" — funds which are formed for the sole purpose of acquiring one or more assets from an original fund — in the first half of last year, according to AVCA 2022 H1 Africa Private Capital Activity Report.
Why is this concerning? The growing practice of selling companies within the same family structure will obviously "distort" returns as companies are traded within the same group.
