Measuring the Value of LP Fund-Selection Skill

Institutional Advisory & Solutions

April 2020

Using our fair comparison framework, we explored the impact of choices an investor in private markets must make including where to invest uncalled and uncommitted capital, the choice of private market strategy, the level of commitment pacing, and the degree of fund diversification per vintage. In addition, we explored the impact of an LP’s fund-selection skill on the risk and return profile of the private capital portfolio.

Given the interplay of the many choices an investor must make, we examined whether there is a class of funds that respond to a type of fund-selection skill more than others. Somewhat counter-intuitively, we found that venture funds (especially early stage) may not benefit the most, in terms of risk-adjusted returns, from fund-selection skill. While mean returns improved, volatility persisted. Mezzanine and real estate funds benefited the most from fund-selection skill.

Among the private market strategies, we found that mezzanine performed best in terms of risk-adjusted returns, irrespective of fund selection skill. However, mezzanine is a small market compared to buyout and real estate, hence there may be less opportunity for larger investments and cross-sectional diversification. The next best strategy is real estate followed by buyout. Venture investments had the lowest risk-adjusted returns because of their high underlying risk, but they still offered a better investment opportunity than public markets, with or without skill.







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