The drawing-up of Solvency II prudential rules has become a matter of major concern for the private equity sector. Its financial impact can be large. As an example, in the French market, in 2007, the total investments in private equity represented €22bn in the balance sheet of insurance companies (FFSA 2008).
They finance 21% of the funds raised (AFIC); thus becoming the leading national investors in unlisted stocks. The current measure for private equity risk, used by the European regulator, leads to a correlation of 0.75 between the performance of private equity and that of listed equities. It is likely to dissuade insurers from investing in this class of assets. The EDHEC Financial Analysis and Accounting Research Centre study examines the robustness of this correlation coefficient and the methodology used to obtain this value.
In addition to casting doubt over the use of VaR (Value at Risk), which requires the implementation of correlation matrices that have been very controversial to date, the EDHEC study questions the representativeness of the LPX50 index selected by the regulator to measure the capital required for private equity investment risk. This index, which is defined on the basis of the stock prices of the fifty largest listed private equity firms in the world (i) is not representative of investments of European insurance companies, either on a geographical level or as a representation of the weight of investments in venture and buy-out, (ii) does not reflect the non-liquid contractual nature of investments in private equity, and (iii) as a result of the underlying investments, the LPX50 poses an idiosyncratic risk that is added to the risk of investment in private equity.
To correct the identified drawbacks of the CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors) approach, EDHEC’s proposal involves replacing the LPX50 index with a benchmark that is more representative of insurance portfolios invested in private equity. The analysis is based on the performance of private equity funds for various investment classes and geographical zones, taken from the Thomson One database. In accordance with the practices of the private equity industry and academic approaches, the EDHEC Financial Analysis and Accounting Research Centre calculated the internal rates of return (IRR) of private equity funds by vintage year, and then measured the return of an equivalent investment in the MSCI indices, with the same portfolio structure as the private equity benchmark (vintage year, incoming and outgoing cash flows, geographic zone). This index is known as the Public Market Equivalent Plus (PME +).
The correlation between private equity and listed market performance is measured using four families of private equity investments (two geographical zones combined with two types of investment: buy-out and venture). In order to provide an optimal reflection of European insurance companies’ investments, these four families were then aggregated into a single portfolio. The results (both by family and for the aggregated portfolio) show that private equity performance is significantly less correlated to that of listed equity markets than assumed in the 0,75 correlation coefficient selected by the CEIOPS ; it lies between 0,11 and 0,54 according to the geographical zone and the type of investment.
Finally, the study shows through simulations the impact of the level of the correlation coefficient (representing diversification in investments) not only on the capital requirement for equity risk but also on the marginal cost of the capital requirement as a consequence of asset reallocation between listed equities and private equity.
This study has received support from the British Private Equity and Venture Capital Association, BVK, the European Private Equity and Venture Capital Association, and was presented to the Ministry of Economy at the Prudential Regulatory Authority.
Joanne Finlay | EDHEC Research Highlights
Antarctic Ice Sheet mass loss has increased
14.06.2018 | Technische Universität Dresden
WAKE-UP provides new treatment option for stroke patients | International study led by UKE
17.05.2018 | Universitätsklinikum Hamburg-Eppendorf
Russian researchers together with their French colleagues discovered that a genuine feature of superconductors -- quantum Abrikosov vortices of supercurrent -- can also exist in an ordinary nonsuperconducting metal put into contact with a superconductor. The observation of these vortices provides direct evidence of induced quantum coherence. The pioneering experimental observation was supported by a first-ever numerical model that describes the induced vortices in finer detail.
These fundamental results, published in the journal Nature Communications, enable a better understanding and description of the processes occurring at the...
In a recent publication in the renowned journal Optica, scientists of Leibniz-Institute of Photonic Technology (Leibniz IPHT) in Jena showed that they can accurately control the optical properties of liquid-core fiber lasers and therefore their spectral band width by temperature and pressure tuning.
Already last year, the researchers provided experimental proof of a new dynamic of hybrid solitons– temporally and spectrally stationary light waves resulting...
Scientists from the University of Freiburg and the University of Basel identified a master regulator for bone regeneration. Prasad Shastri, Professor of...
Moving into its fourth decade, AchemAsia is setting out for new horizons: The International Expo and Innovation Forum for Sustainable Chemical Production will take place from 21-23 May 2019 in Shanghai, China. With an updated event profile, the eleventh edition focusses on topics that are especially relevant for the Chinese process industry, putting a strong emphasis on sustainability and innovation.
Founded in 1989 as a spin-off of ACHEMA to cater to the needs of China’s then developing industry, AchemAsia has since grown into a platform where the latest...
The BMBF-funded OWICELLS project was successfully completed with a final presentation at the BMW plant in Munich. The presentation demonstrated a Li-Fi communication with a mobile robot, while the robot carried out usual production processes (welding, moving and testing parts) in a 5x5m² production cell. The robust, optical wireless transmission is based on spatial diversity; in other words, data is sent and received simultaneously by several LEDs and several photodiodes. The system can transmit data at more than 100 Mbit/s and five milliseconds latency.
Modern production technologies in the automobile industry must become more flexible in order to fulfil individual customer requirements.
13.06.2018 | Event News
08.06.2018 | Event News
05.06.2018 | Event News
25.06.2018 | Physics and Astronomy
25.06.2018 | Earth Sciences
25.06.2018 | Power and Electrical Engineering