Venture Capital and Buyout Funds as Alternative Equity Investment Classes

Abstract

This research uses quarterly data from 1986 through 2001 to evaluate the risk and return performance of venture capital and buyout funds as alternative equity investment classes. Several results are noteworthy. First, pooled VC and buyout fund returns are 2.5% and 2.8% (on a quarterly basis) above the CAPM risk-adjusted returns. The superior alphas of the alternatives, however, are subject to biases due to potential income smoothing in the reporting process, illiquidity of private equity investments, and heterogeneity of fund returns. Second, VC but not buyout returns are strongly related to the returns on the overall equity market index and the book-to-market value factor in three-factor models. There is a stronger linkage between venture capital funds and public equity markets, and a weaker linkage between buyout funds and the public equity markets. Finally, both venture returns and buyout returns are strongly related to the growth in industrial production, demonstrating the cyclical nature of the private equity industry.