A private market equivalent benchmark is superior to either peer group benchmarks or a public market equivalent in measuring private equity and infrastructure manager outperformance, according to Frederic Blanc-Brude, director of Scientific Infra & Private Assets at EDHEC Asia Pacific.
Speaking at the Fiduciary Investors Symposium in Singapore, Blanc-Brude said using a combination of private market benchmarks, the relevant cash flows and net asset value, and a well-established methodology known as direct alpha, can reveal a new perspective on manager outperformance.
Referring to new research, Do private asset funds generate alpha, he showed that on average private asset managers do not deliver alpha if they are benchmarked against the appropriate index.
It shows that private market risk is the primary driver of returns in private asset funds. Further asset allocation alpha is positive or in other words fund managers create value by taking contrarian bets on specific sectors.
The paper looks at how to measure alpha in a way that will greatly improve how private markets managers are selected, according to Blanc-Brude, with the current method inferior due to a forced trade-off between a robust peer group and granularity.
EDHEC estimates that the private asset market is made up of millions of companies across 150 countries with combined assets of $65 trillion, and Blanc-Brude argues “a more prudent approach to selecting these managers” would be to use a benchmark for this market made up of the underlying companies. EDHEC has derived two benchmarks – the private2000 and infra300 indices – which are based on a robust asset pricing model that reprices one million companies monthly.
“Because so far, we have been looking at our peer group of funds, we’ve been conflating two things, the beta of the fund, in other words how much is exposed to this private asset market, and the alpha of the manager, how much they beat the market,” he said. “It’s all mixed together because you can’t tell which is which. And the prudent investor should try to select fund managers that can at least deliver the market, deliver the beta of private equity, and ideally do better.”
Blanc-Brude dismissed the idea of using a benchmark made up of a public-market equivalent, saying “the only information that gives you is if you’re better of investing in an ETF versus private equity”.
“Which is interesting, it’s not zero information, but that’s all it’s going to tell you. It’s certainly not going to help you to find the best manager.”
“So in order to select the best managers that are the most likely to create value, you should be using an index which allows you to distinguish between their exposure to a market, which is the market they invest in, this private market, and which part of what they do is outperformance.”
The study also segments managers into four categories according to positive or negative alpha and positive or negative beta, noting there are those that are “quite special” who have negative beta but positive alpha.
These are really those who are managing to create value without getting too much market risk exposure.
