Hans Holmen's Blog
THRUSTING SOCIAL INVESTMENT INTO THE MAINSTREAM
21 September 2011 by Hans Holmen
Last week, the Coller Institute co-hosted an event with the Deloitte Institute of Innovation and Entrepreneurship (“DIEE”) on Venture Philanthropy and Social Ventures. A first class panel comprising Daniela Barone Soares, chief executive of Impetus Trust, Sir Ronald Cohen, advisor to Big Society Capital, David Hutchison, chief executive of Social Finance, Johannes Huth, KKR and chairman of Private Equity Foundation and Gary Dushnitsky, academic director of DIEE assembled to discuss the escalating influence and proliferation of social investment from a variety of perspectives.
What exactly is social investment? An easy place to start you might think but it was immediately apparent that there was no agreed single definition even amongst the panellists! Many in the audience espoused models of investment for the greater good of society and investment where financial return is of secondary benefit or purpose. Whichever way the term is defined, it is clear that social investment features prominently on the agenda of philanthropists, charities, corporates and governmental policy advisors . This was obvious and reflected the diversity of our audience which included private equity practitioners, management and trustees of charities and foundations, professional services firms, banks, academics and students.
Why does ”Social Investment” resonate across the spectrum? In one word – size and then as an addendum; its potential.
- The ‘social sector’ or ‘third sector’ now employs over 40 million people globally
- Over 200 million people volunteer their services for the ‘social sector’
- More than 30 universities around the world run programmes on social entrepreneurship
- The European Venture Philanthropy Association now has 135 members from 20 countries
With the increasing gap between rich and poor and the withdrawal of government investment (I am not commenting on causality) the demand for social entrepreneurs can only increase. At the same time, investors/philanthropists are seeking to optimise returns for their donations given the ever increasing demands for such funding. These returns or KPIs are at the heart of social investment ethos. They are essential to create the “currency” whereby one investment can be compared to another, fundamental in the equation to determine the classic economic pay off structure.
Once considered the domain for governments, the boundaries between economic and social investment have blurred. In developing markets where government support is weak, social entrepreneurs have been instrumental in creating organisations providing healthcare, education and micro finance. In developed markets, privately financed organisations such as venture philanthropy firms (eg Impetus Trust), have been established, providing philanthropic support to social enterprises as well as management skills and specialist expertise. Many of these organisations were established by high net worth individuals looking at giving back to the community. These individuals have been instrumental in ‘professionalising’ charities, defining and focussing on KPIs, thereby transforming them into investable organisations.
It is wise to remember that whilst impact KPIs may be bespoke and critical, KPIs on financial health and operational issues must also be met to ensure sustainable deliverability. The establishment of market intermediaries and advisers have followed the professionalization of the industry.
Once some semblance of critical mass is evident, financial innovation is usually responsive and adept at developing markets to aid the flow of capital. Social Investment or “Impact” capital is not immune to these forces.
Social impact bonds have been mooted as the tool or mechanism for scaling this market. Social impact bonds are an outcomes based contract that align returns to a mission, to improve an aspect of society (eg reducing reoffending). The private investors are reimbursed by (so far) the government and achieve a financial return only if certain KPIs are exceeded (eg the reoffending rate). If these KPIs are not met, the investors lose their money. The creation of measurable KPIs is key to attract additional capital from investors rather than or solely from governments. However, governments tend to be departmental so that the costs and benefits may straddle departmental budgets and costs will be incurred years before the benefits are seen, making governments problematical as a coupon payer. Maybe it is best for them to have skin in the game through tax incentives in the hands of investors.
Intermediaries such as Social Finance will need to play a key role in educating and drawing together issuers and investors in order to see this market grow. Venture philanthropy firms to date have played a key role in instilling KPIs in their portfolio organisations.
Demographics, the internet and social media have played an important role in developing the market for impact capital. The creation of social enterprises has been embraced by the younger population and social media has made it easier for social entrepreneurs to spread the word about their causes at a low cost.
Government policies have also facilitated social enterprise. Examples are the Social Innovation Fund in the US and the Social Enterprise Investment Fund and the launch of Big Society Capital in the UK.
The above factors have all been contributors to driving social enterprise beyond just a niche place in the economic spectrum, between purely financially motivated businesses and public services to one that is clearly resonating through boardrooms and government committees and advisors.
Hans Holmen and Ann Iveson
We are interested in your views of the future of the social investment market.
- Why are you / your organisation interested in the sector?
- What could the private sector and government be doing differently / better to drive more investment?
- How are social returns most effectively measured?
- Where next for Social Impact bonds? What problems aside from reoffending could they help? Will it be charity driven or Foundation/investors driven? Could a group of charities sharing a mission, pool together or is it a piecemeal solution for the larger charities?
The best response will win a copy of International Private Equity authored by Professors Eli Talmor and Florin Vasvari of London Business School.
For more coverage of venture philanthropy, please see a Coller Institute of Private Equity/LBS research paper that showcased Impetus Trust, entitled Catalysing Systemic Change: The Role of Venture Philanthropy at http://www.collerinstitute.com/Research/Paper/142 and an interview with Daniela BaroneSoares to be featured in the next edition of the Business Strategy Review at http://www.collerinstitute.com/News/StudentNews/15.
COLLER PRIZE EVENING
01 December 2010 by Hans Holmen
The Coller Prize has been an annual fixture of the Coller Institute of Private Equity for five years, recognising the best student research in the field of private equity and venture capital. To reflect the ever growing research in the field, the Coller Prize has expanded greatly since 2006. In 2008, the Institute awarded separate prizes for the best case study and best management report for the first time.
This year, the Institute introduced an additional category for PhD students, which is open to students from around the globe. A vast quantity of high quality submissions were received, making the judging process a challenging one.
This year’s Coller Prize award evening was held at London Business School on 30 November 2010. David Thorp (MSc04), Partner, ISIS Equity Partners and Chairman, Sussex Place Ventures, introduced the evening in front of a packed audience comprising current students, alumni, academics and private equity practitioners. Mr Thorp, an alumnus of London Business School and an experienced practitioner, discussed research in private equity and his own research on venture capital and start-ups when he was a student at the School. He gave Coller Capital as an excellent example of how to develop an entrepreneurial spirit by taking a concept and transforming it to be a successful secondaries fund of funds manager with truly a global reach. Within this context he stressed the importance and relevance of the work done by the Coller Institute as a leading research centre and forum for debate in private equity. Furthermore, I am sure his speech inspired a number of current students in the audience to get involved in private equity research!
Following the introductory speech, Professor Eli Talmor, Chairman of the Institute presented the awards for the Best Management Report and Best Case Study. Winners received a cheque for £1750 and a trophy. We are pleased to announce the following winners and runner-ups for these categories:
Best Management Report
Joao Estrela and Eze Vidra, both SEMBA 2010 for Real Money in Virtual Goods? A Venture Capital Scan on the Virtual Goods Industry
Amit Paul and Anupam Sharma, both MBA 2010 for Private Equity Secondaries – Investment Opportunities in the Cleantech Sector
Best Case Study
Adolfo Vinatea and Richard Turner, both MBA 2010 for Mekong Capital: The Importance of Corporate Culture in Emerging Markets Private Equity
Ananth Yvas Bhimavarapu and Thibaud Simphal, both MBA 2010 for Bridging the SME early-stage finance gap: A case study on Capital for Enterprise UK
James Marks and Pete Wong, both MBA 2010 for Catalysing Systemic Change: The Role of Venture Philanthropy
The awards were presented by Stephen Ziff, Partner, Coller Capital and the winners of both categories presented their papers to the assembled audience.
Professor Francesca Cornelli, Academic Director of the Institute presented the inaugural PhD prize. This is an important addition to the Coller Prize and reflects the objective of the Coller Institute to expand its reach beyond London Business School and recognise the world’s best private equity research, just as it does with its publication, Private Equity Findings. The winner received a cheque for USD 5,000 and a trophy.
The awards were presented to:
Ji-Woong Chung, currently of Ohio State University for Performance Persistence in Private Equity Funds
Linus Siming, currently of Bocconi University for Your Former Employees Matter: Private Equity Firms and Their Financial Advisors
Both winner and runner-up presented a synopsis of their papers to the audience.
The evening exemplified the growing quality of research in the field of private equity and venture capital. As private equity emerges from the financial crisis and the industry reflects on lessons learned during this period, research in the field will be critical on how the industry has been able to create and realise value, how GPs have interacted with their investors and the effect of new regulatory measures. As a leading forum for debate, the Coller Institute will continue to showcase the globe’s best private equity research, bridging the worlds of academia and industry.
Thank you to all involved in this year’s Coller Prize including a special thanks to Katharine Campbell, Cambridge Associates for her role in judging the case study and management report categories with Hans Holmen, Executive Director of the Institute.
All presentations will be made available for download on the Institute’s website at www.collerinstitute.com.
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THE PE PERFORMANCE PUZZLE
23 September 2010 by Hans Holmen
Professor Chris Higson, Professor of Accounting at London Business School spoke at a seminar facilitated by the Coller Institute of Private Equity at City Week – the UK International Financial Services Forum.
Professor Higson’s speech addressed the puzzle relating to private equity performance. This speech was a follow up to his introduction in Issue 2 of Private Equity Findings to the article “The Point of No Return” which attempted to demystify whether private equity offers the outperformance necessary to compensate investors for illiquidity and risk. You can find a copy of the presentation and other research mentioned in this blog in our research library.
The issue of performance has become a question not only for investors but for broader society. While society is interested in whether private equity investors make businesses more valuable, in other words the gross returns to private equity, investors are interested in the net returns and how much of the return general partners (GPs) capture.
Chris Higson firstly summarised the various academic studies on the topic which looked at returns from buyouts from 1980 through to the early 2000s. Steve Kaplan, University of Chicago Booth School of Business and Antoinette Schoar, MIT Sloan School of Management obtained a large sample of US buyout funds using a Venture Economics database and assessed that average returns net of fees are roughly equal to the S&P 500. Ludovic Phalippou, University of Amsterdam and Oliver Gottschalg, HEC Paris, used a sample of global buyout funds, again obtained through Venture Economics. Their research showed returns are 3% below the S&P 500 and 6% below when adjusted for risk. Alexander Ljungqvist and Matthew Richardson, both from the NYU Stern School of Business, obtained timed cash flow data from a single limited partner (LP) and calculated returns to be an excess of 5 – 8% over the S&P 500.
Professor Higson pointed to the wide variation in performance between buyout funds, specifically noting that, based on BVCA figures, half of funds pay no carry and 10% of funds actually lose 50% of their capital. However, the top performers consistently do well and evidence suggests there is some persistence in top performing funds.
The measurement of private equity performance is difficult because there is no active market, unlike the market for quoted corporate acquisitions for which data is easily available. Furthermore, considering the way buyout funds are structured, it can take 10 years or more to wait for funds to exit their portfolio investments and pay out cash. To take the academic research mentioned above as examples, Ljungqvist and Richardson used data from a single LP, raising the question of selection bias where the other studies used data from Venture Economics which includes data on unrealised investments. Also, what is the appropriate benchmark? Chris Higson pointed to the S&P 500 as the default comparator but adjustments are required for illiquidity and leverage risk inherent in the private equity asset class.
So what is the research telling us? Chris Higson commented that despite the difficulties in performance measurement, the results are not inconclusive. Though we have to see research on private equity performance as work in progress, the evidence so far suggests an economy where private equity generates gross returns in excess of the market return but adjusted for fees, limited partners get at best a market return. GPs take most of the pie.
This begs the question – why do LPs continue to invest in the asset class when average returns are at best at market? If the top quartile funds consistently outperform then the remainder must be underperforming. The obvious answer is to invest only in the top quartile funds. However, this club is not easy to join. Chris Higson commented that the answer to this question continues to be a puzzle.
Professor Higson pointed to the 2 and 20 performance model and if GPs capture most of the economic rents through this model, the focus should be on performance attribution – what value the GP actually adds. Chris mentioned a recent study by Eli Talmor, London Business School, Florin Vasvari, London Business School and Oliver Gottschalg on this very topic. This research was able to access fund level cash flow data, net of fees for a single LP and attempted to quantify the outperformance of these funds compared with a public market equivalent (ie an ‘alpha’). In the sample analysed, buyout funds’ alpha was 4.47%. Leverage was the single highest contributor to returns, adding 7.71% to the return of the average buyout fund. LPs will look for their GPs to generate the highest possible alpha for them to justify their fees.
Looking to the future, Professor Higson believes there are two main drivers for PE continuing to maintain sustainable competitive advantage – better governance and possession of a powerful cluster of human capital with great intellectual capacity and strong networks. LPs will become more discriminating in respect of in which funds to invest and also will become more demanding. The industry will become smaller with the strong GPs surviving and thriving and the poor GPs falling away.
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