Drawdown Distribution as an Explanatory Variable of Private Equity Fund Performance

The first four to five years of a Private Equity (PE) Fund’s life are known as the investment period. In this period, the fund usually draws down committed capital to make investments into portfolio companies. Although it is typical that funds drawdown most of the capital during the first five years, GPs have the autonomy to invest capital even after the investment period ends because of a lack of good opportunities. However, this is uncommon because it leaves little time for the GP to create value in these investments before they are required to exit them prior to the expiration of the fund life. This paper aims to investigate the relationship between the drawdown distribution over the life of the fund and PE buyout fund returns. Before doing so, this paper brings together different explanatory variables found to be significant in previous relevant studies to form a base-case regression. Using Preqin Data, this study is based on 281 buyout funds with vintages from 1995 to 2005. After running numerous multi-variable regression, the combination of three factors consisting Corporate-BAA bond yield of the fund’s vintage year, Average S&P500 returns over the Fund’s Life and the Fund Number were found to be the most significant group of variables and thus formed the base-case regression. Vintage year was found to be insignificant when macro-economic variables were added to the regression. Using the same principles of calculating bond duration, the drawdown distribution of a fund can be captured in a single duration-like variable where fund distributions are time-weighted – the earlier the drawdowns, the lower the variable. This Drawdown Distribution Variable (DDV) was shown to be significant in explaining PE fund returns at a 95% confidence level. Though the increase in Rsquared is little, a partial F-test shows that DDV does increase the explanatory power of the multivariable regression model. As hypothesized, the relationship between DDV and PE fund returns is negative where the later the drawdowns (the higher the DDV), the lower the PE returns.