Valuing Private Equity Investments Strip by Strip

Abstract

We propose a new valuation method for private equity (PE) investments. It constructs a replicating portfolio using cash flows on listed equity and fixed-income instruments (strips). It then values the strips using an asset pricing model that captures the risk in the cross-section of bonds and equity factors. The method delivers a risk-adjusted profit on each PE investment and a time series for the expected return on each fund category. We find negative risk-adjusted profits for the average PE fund, with substantial heterogeneity and some persistence in the performance. Expected returns and risk-adjusted profit decline in the later part of the sample.