Manager selection is critical to private equity returns, and a variety of analyses are often employed to quantify and improve the selection process. These include analysis of returns by quartile, public market equivalent (PME) analysis and the conventional attribution analysis, often referred to as the "value bridge." These methods share a common goal of increasing transparency regarding performance and returns, but the value provided by this transparency is often quite limited.
Investors often seek to measure alpha, or the excess return relative to a relevant benchmark, to identify managers that have outperformed their respective benchmarks and can potentially repeat their outperformance with future investments. Alpha is especially hard to measure in the context of private equity given the challenge of benchmarking portfolio company performance and isolating organic growth.
We define created-value alpha (Alpha) as organic value creation on a company-specific outperformance basis relative to an appropriate industry benchmark. Unfortunately, the value bridge and other methods described above do not isolate or identify Alpha, and to accurately identify and measure Alpha, a more robust attribution framework is required.
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