The Economic Rational of Private Equity Funds Abstract

The Economic Rational of Private Equity Funds

Abstract:

Proliferation of Private Equity Funds (PEF) and available data accumulated over the past few decades has translated into a multiplicity of analysis of sector’s performance. However, unconclusive results fail to confirm PEF return’s dominance over alternative investments. Something that was expected to justify the exponential growth exhibited by the sector.

Recent evidence shows an incipient but growing trend of disintermediation as large investors try to avoid fund’s high costs and agency problems. Such trend comes to question the validity of the structure demanding a closer look at the economic rational of the sector.

We propose addopting an alternative approach to the economic rational of funds by considering them as syndication mechanisms able to solve investor’s coordination problems. Syndication is valuable because it allows investors to achieve higher diversification, pooling resources into larger transactions and fee pooling of expensive management teams. However, limited partner’s access to crucial information and influence on key investment decissions of the fund can be a source for conflicts of interest unless investors undertake exclusivity commitments with the fund. Impossing an arms lenght relation of investors with the fund while delegating management to dedicated profesionals is a way to overcome such problems. Management exclusivity and investors exclusion from management becomes then a prerequisit for syndication.

Funds are then futures non-exclusive agreements of institutional investors that syndicate arms lenght investments delegating management to a general partner that operates under exclusivity for a fee. That structure allows investors to capture syndication benefits without the hustle of confrontation over investment decissions. Fund’s appeal stems then from the diversification and risks treatement made posible by syndication and is not limited to asset dominance of private equity achievable also through solo investments.

Keywords: private equity funds/ venture cap- ital/ buy outs.