Risk of Private Equity Fund-of-Fund Investments - A Detailed Cash Flow-Based Approach

32 Pages Posted: 26 Mar 2009

See all articles by Ann‐Kristin Achleitner

Ann‐Kristin Achleitner

Technische Universität München - Center for Entrepreneurial and Financial Studies

Reiner Braun

Technische Universität München (TUM) - TUM School of Management

Matthias Schaller

Risk Solution Network AG

Florian Tappeiner

Technische Universität München - Center for Entrepreneurial and Financial Studies

Date Written: March 25, 2009

Abstract

Fund-of-fund investments in private equity are becoming increasingly popular due to their potential to diversify across several private equity funds. However, due to the illiquidity and opaqueness of private equity markets only limited knowledge is available on the actual risk profile of fund-of-funds. Hence, we aim at contributing to the field by modeling, quantifying, and testing sensitivities of the risks associated with such investments. We design a detailed cash flow model and adopt the value-at-risk approach, which is modified to fit the two most common measures of return, namely internal rate of return (IRR) and multiple. Based on a proprietary data set of historical transactions we simulate fund-of-funds investments. Further, sensitivity analyses of central input parameters show the impact on risk and return. While reducing the management fee and the carried interest would lead to higher returns, increased diversification reduces risk. Based on our model, reducing the current industry standard of 2% management fee and 20% carried interest of private equity funds increases the mean IRR by 4.3 percentage points.

Suggested Citation

Achleitner, Ann-Kristin and Braun, Reiner and Schaller, Matthias and Tappeiner, Florian, Risk of Private Equity Fund-of-Fund Investments - A Detailed Cash Flow-Based Approach (March 25, 2009). Available at SSRN: https://ssrn.com/abstract=1368277 or http://dx.doi.org/10.2139/ssrn.1368277

Ann-Kristin Achleitner

Technische Universität München - Center for Entrepreneurial and Financial Studies ( email )

Arcisstr. 21
Munich, D-80290
Germany
+49 89 289 25181 (Phone)

Reiner Braun

Technische Universität München (TUM) - TUM School of Management ( email )

Arcisstr. 21
Munich, Deutschland 80333
Germany
+498928925181 (Phone)
+498928925188 (Fax)

HOME PAGE: http://www.ef.wi.tum.de/

Matthias Schaller

Risk Solution Network AG ( email )

Albisriederstrasse 80a
Zurich, Zurich 8003
Switzerland

Florian Tappeiner (Contact Author)

Technische Universität München - Center for Entrepreneurial and Financial Studies ( email )

Arcisstr. 21
Munich, 80333
Germany

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