“Skill and Luck in Private Equity Performance” by Morten Sorensen
We evaluate the performance of private equity funds using a variance decomposition model to separate skill from luck. We find a large amount of long-term persistence: skilled PE firms outperform by 7% to 8% annually, on average. However, performance is noisy, with a large amount of luck, so top-quartile performance does not necessarily imply top-quartile skills. This makes it difficult for investors (limited partners) to identify skilled firms. Buyout firms show the largest skill differences, implying the greatest long-term persistence. Venture capital performance is the most noisy, making skilled venture firms hardest to identify, and implying the least investable persistence.