Over the past three decades, institutional investors have controlled an increasing share of the US equity markets, exceeding 50% from 1995, according to academics Paul Gompers and Andrew Metrick.
The importance of institutional investors – pension funds, insurance companies and funds of funds – has also been seen in private equity and venture capital (VC), but research by a trio of US academics has found that not all investor types performed equally well.
The three, Josh Lerner, at Harvard University and the National Bureau of Economic Research, Antoinette Schoar, Massachusetts Institute of Technology and the NBER, and Wan Wong, also from Harvard University, said, in their paper Smart Institutions, Foolish Choices? The Limited Partner Performance Puzzle, that even after controlling for fund type and vintage year, endowments outperformed as limited partners (LPs – investors) in funds by between 9% and 12% each year.
The average internal rate of return (IRR) – a measure of annual performance – of funds in which endowments invested was 20% by 2001. Overall, endowments had a very positive average as they invested in many more venture capital than buyout funds with an average IRR of 35% and 19% in early and later-stage VC funds respectively.
However, funds picked by advisers and banks had very poor performance on average (IRRs of -2% and -3% respectively) across all different types of private equity investments.
The paper added: "Interestingly, bank and finance companies picked particularly poor-performing funds among the early-stage VC funds (IRR of -14%)."
The academics said: "Banks have long been important private equity investors. The motivations for their investment activity, however, are frequently more complex than those of other LPs.
"While they also seek to earn high returns, their investment decisions are often shaped by indirect considerations as well. For instance, many banks garner substantial profits from lending to firms undergoing leveraged buyouts or from advising on these transactions.
"As a result, they may invest in a buyout fund that they do not expect to yield high returns if the investment will increase the probability they will generate substantial fee income from the group’s transactions."