GP turnover delivers improved fund performance - study

Using data mined from Capital Dynamics' due diligence database, researchers at LBS' Coller Institute of Private Equity analyzed the backgrounds and investments of 145 management teams from around teh world together with corresponding deal and fund performance attributed over a 20-year period.

They found that teams experiencing turnover from one fundraising to the next performed better on the next fund, with a 1% increase in turnover leading to a 10% improvement in subsequent net IRR. The thesis holds out even during recessions, with a 1% increase in turnover leading to a 3.1% jump in IRR.

The average net IRR of managers with the highest turnover was 25% compared with 11.5% for those with the lowest turnover.

"Our findings suggest a new team attribute - team evolution. Team evolution should be considered during due diligence, as the ability of a team to adapt to changing economic environments - as our study shows - can be more important than the team's stability," said Ivan Herger, head of research at Capital Dynamics, in a statement.

When broken down by job type, the results indicate that a higher turnover of professionals with operational backgrounds produced a significant improvement in performance. Turnover of professionals with financial backgrounds had negligible impact on performance. "Financial skills appear to be a commodity," the study concluded.

Change within an operating team may reflect the nature of the assets in a private equity firm's portfolio and deal pipeline, a phenomenon that is unlikely to worry investors unduly.

In contrast, continuity is encouraged among the core private equity professionals who set up the firm and define its strategy. Indeed, the study found that a high turnover of professionals with PE background contributes to a decline in performance between funds, highlighting the need for effective succession planning.

Examined on a deal-by-deal basis, when there was high turnover of investment professionals on a particular transaction, performance suffered more than those with lower turnover. Stable teams delivered a gross IRR or 32%, compared to 20% for groups experiencing volatility.

However, the study noted that the underperformance of deals could have led to staff turnover. Deals with good prospects of generating substantial carried interest for investment professionals generally didn't exhibit team turnover. "While the ‘the chicken or the egg' dilemma remains, in general, we can maintain that deal turnover is associated with weakened performance," the study said.

The full report can be found here.

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