1. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Listed Private Equity Cumming & Johan (2013, Chapter 8) 1

2. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Limited partnerships: PE firms are the management company that operate a PE fund (or a set of PE funds Introduction Theory Data Tests Conclusion Institutional Investors PE Fund Investee Firm ReturnsCapital Equity, Debt, Warrants, etc. Capital Recall: Cumming and Johan (2013 chapter 5) show international differences in PE fund structures depends on human capital and institutional setting 2

3. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Listed Private Equity is Different Introduction Theory Data Tests Conclusion Either the PE fund or the PE firm is listed on a stock exchange A listed private equity firm (the management company), provides shareholders an opportunity to gain exposure to the management fees and carried interest earned by the investment professionals and managers of the private equity firm. – E.g., Blackstone Group on June 22, 2007. Traded on NYSE under symbol BX A listed private equity fund or similar investment vehicle, which allows investors that would otherwise be unable to invest in a traditional private equity limited partnership to gain exposure to a portfolio of private equity investments – E.g., Kohlberg Kravis Roberts raised $5 billion in IPO for KKR Private Equity Investors (“KPE”), Euronext in Amsterdam (ENXTAM: KPE) on April 18, 2006. – E.g., Fortress, February 7 2009 3

4. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Blackstone IPO Introduction Theory Data Tests Conclusion On March 22, 2007, the Blackstone Group filed with the SEC to raise $4 billion in an initial public offering. The offering was underwritten by Morgan Stanley and Citigroup, with smaller roles played by Merrill Lynch, Lehman Brothers, Credit Suisse and Deutsche Bank. On June 21, Blackstone swapped a 12.3% stake in its ownership for $4.13 billion in the largest U.S. IPO since 2002. Traded on the New York Stock Exchange under the ticker symbol BX, Blackstone priced at $31 per share on June 22, 2007. 4

5. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Stock Performance of Blackstone Group Introduction Theory Data Tests Conclusion 5

6. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Fortress IPO Introduction Theory Data Tests Conclusion On February 9, 2007 Fortress became the first hedge fund and private equity company to go public in the United States when it sold an approximately 39% stake and raised $634 million. Goldman Sachs and Lehman Brothers were the lead underwriters of the offering, along with Bank of America Securities, Citigroup and Deutsche Bank. Fortress made an impressive market debut and after the first day of trading, its shares were selling at a 68% premium compared to the offer price of $18.50. 6

7. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Stock Performance of Fortress Introduction Theory Data Tests Conclusion 7

8. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Broader Statistics on Listed Private Equity Introduction Theory Data Tests Conclusion How many funds currently? – LPEQ (Europe): 80 investable listed private equity companies as at 2008, with market capitalisation of £22 bn (€25 bn) of which £11 bn are London-listed companies – Standard & Poor's (US): 80 listed private equity businesses trading on developed market exchanges, with market capitalization of more than US$ 250 million. Performance expectations for the asset class? – Tends to show underperformance – Caveat: many studies include VCTs, and LPEQ argues not listed PE Note: tax subsidized schemes like LSVCCs (Canada) and VCTs (UK) are not considered listed private equity – Many statutory constraints, hurts governance/performance 8

9. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Main Issue in this Chapter Introduction Theory Data Tests Conclusion Given mixed performance to date, who invests in listed private equity, and why? 9

10. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Prior work (1 of 2) Introduction Theory Data Tests Conclusion Lahr and Kaserer (2009 WP): – 1992-2008 – 79 ordinary funds and 21 listed PE funds – Listed PE funds start at an initial premium of -2.5 % and adapt to the long-term average of -21 % after two years. – Premia predict future returns and are explained by liquidity but not by investor sentiment or the fund's investment degree. – Private equity fund premia seem to depend on credit markets and systematic risk. 10

11. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Prior work (2 of 2) Introduction Theory Data Tests Conclusion Jegadeesh, Kräussl and Pollet (2009 WP) – 26 private equity fund-of-funds and 129 listed private equity funds over 1994-2008, – Estimate the market’s expectation of unlisted private equity funds (via fund-of-funds) abnormal returns (and net of their fees) to be 1-2% above the market accounting for risk, – Estimate the market’s expectation for listed private equity abnormal returns is zero to marginally negative. – Betas of listed private equity and unlisted private equity (via fund- of-funds) are close to one. – Private equity fund returns are positively correlated with GDP growth and negatively correlated with credit spread. 11

12. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting New insights in this chapter Introduction Theory Data Tests Conclusion First to document who invests in the asset class of listed private equity, and why Perspective of institutional investors Data from LPEQ and Preqin – Leading source of information on Listed Private Equity – 171 institutional investors in Europe, 2008-2010 12

13. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Who Invests? Search Costs Introduction Theory Data Tests Conclusion Hypothesis 8.1A: Listed private equity is a more attractive asset class for smaller institutional investors. Hypothesis 8.1B: Listed private equity is more commonly considered by institutional investors based in the UK than their counterparts in continental Europe. 13

14. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Who Invests? Specific Human Capital Introduction Theory Data Tests Conclusion Hypothesis 8.2: Listed private equity is more likely to be considered by an institutional investor whose decision making is delegated to an equities team as compared to delegation to a private equity team or an alternative asset team. 14

15. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Who Invests? Liquidity Time Preference Introduction Theory Data Tests Conclusion Hypothesis 8.3: Listed private equity enables institutional investors to achieve their target private equity allocations quicker, and as such, institutions that invest in listed private equity are more likely to adjust their listed private equity allocations over time in response to slower adjustments to limited partnership private equity allocations. 15

16. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Data Introduction Theory Data Tests Conclusion 171 institutional investors in Europe – 34% investors have listed private equity in their investment mandate – 18% investors have a variable listed private equity allocation over time For investors that have listed private equity in their investment mandate, the average allocation to listed private equity relative to limited partnership is 8.34% For all investors in the sample, the percentage of investments into listed private equity relative to total assets under management is 0.54% – And 1.60% for the subset of investors with listed private equity in their investment mandate 16

17. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Characteristics of Investors in Sample Introduction Theory Data Tests Conclusion Size – The average institutional investor in the sample manages over €35.5 billion, with the median at €2.2 billion. Types – 1 investment bank, 2 endowments, 59 family offices, 14 banks, 24 private pension funds, 24 insurance companies and 44 public pension funds. Countries: – UK (50), Switzerland (26), Denmark (5), Netherlands (12), Finland (10), Germany (26), Liechtenstein (2), Sweden (7), France (3), Italy (2), Austria (4), Belgium (2), Greece (2) 17

18. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Some Attractions to Listed PE Introduction Theory Data Tests Conclusion 89% report improved liquidity 57% report afforded access to private equity without any delay 46% report an attractive way to invest after the “J-curve” – meaning lower returns at the start of a fund’s life due to management fees and other costs, but higher returns later in a fund’s life as capital is invested and investments are harvested 67% report simplified administrative burdens and cash flow management relative to limited partnership private equity. 18

19. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Table 2: Comparison Tests Introduction Theory Data Tests Conclusion A significantly higher proportion of private pension funds invest in listed private equity (24%) than those that do not (9%), – In Europe, private pension funds often have significantly smaller investment teams than public pension funds, and as such have less time and expertise to carry out due diligence and review and negotiate limited partnership contracts. – Smaller pension funds may use listed private equity as an easy way to obtain diversification, either via a listed fund of funds or via a portfolio of direct listed private equity vehicles. – Investing in listed private equity not only lowers due diligence and review costs, but also improves diversification. 19

20. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Table 8.2. Comparison Tests Listed PE Part of Investment MandateListed PE Not Part of Investment Mandate Comparison of Means (or Proportions) Mean (or Proportion for Dummy Variables) Median Mean (or Proportion for Dummy Variables) Median Institutional Investor Characteristics Assets Under Management€ 62,179.60 € 2,224.10 € 21,819.40 € 2,140.00 0.86 (P’=0.81 for comparison of medians) Family0.260.000.390.00-1.70* Private Pension Plan0.240.000.090.002.72*** Public Pension Plan0.220.000.250.00-0.34 Bank0.090.000.080.000.15 Insurance Company0.170.000.120.000.86 Investment Bank0.00 0.010.00-0.72 Endowment0.020.000.010.000.48 Fund of Funds0.00 0.010.00-0.72 PE Firm0.00 0.010.00-0.72 Investment Manager0.00 0.040.00-1.45 20

21. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Listed PE Part of Investment MandateListed PE Not Part of Investment Mandate Comparison of Means (or Proportions) Table 8.2. (Continued) Mean (or Proportion for Dummy Variables) Median Mean (or Proportion for Dummy Variables) Median Location UK0.330.000.270.000.85 Switzerland0.170.000.140.000.53 Netherlands0.120.000.040.001.85* Finland0.070.000.050.000.42 Germany0.070.000.190.00-2.05** Sweden0.090.000.020.002.14** Denmark0.00 0.040.00-1.63 Liechtenstein0.020.00 1.40 Iceland0.030.00 1.99** Norway0.030.000.040.00-0.31 France0.00 0.040.00-1.45 Italy0.00 0.020.00-1.02 Austria0.00 0.030.00-1.25 Belgium0.00 0.020.00-1.02 Greece0.00 0.010.00-0.72 Pan European0.070.000.100.00-0.62 21

22. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Listed PE Part of Investment MandateListed PE Not Part of Investment Mandate Comparison of Means (or Proportions) Table 8.2. (Continued) Mean (or Proportion for Dummy Variables) Median Mean (or Proportion for Dummy Variables) Median Internal Investment Decision Making The Private Equity Team0.220.000.270.00-0.59 The Equities Team0.040.000.040.00 The Alternative Asset Team0.050.000.110.00-1.19 The Board / Investment Committee0.430.000.320.001.45 Consultant0.170.000.130.000.70 Beliefs of Decision Makers Listed Private Equity Offers More Liquidity than Limited Partnerships 0.901.000.881.000.23 Listed Private Equity Allows Access to Private Equity Immediately 0.741.000.480.003.29*** 22

23. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Regression Analyses Introduction Theory Data Tests Conclusion Table 4 Logit Analysis of Listed PE Allocation – Whether there is a listed PE allocation – Whether the listed PE allocation changes over time – Whether or not listed PE investment depends on fund managers simultaneously managing private PE funds Table 5 Percentage Allocation to Listed PE – Percentage of listed PE versus other PE – Percentage of listed PE relative to total assets – Difference between target PE allocation and actual PE allocation 23

24. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting General Form of Econometric Models Introduction Theory Data Tests Conclusion Invest in Listed Private Equity = f [constant, institutional investor characteristics (size, type), location, decision making (equities team, private equity team, etc.), beliefs of decision makers] Present two sets of explanatory variables to show robustness. – 1 st one includes assets under management in a linear specification with dummy variables for private and public pension funds; additional dummy variables for other types of institutional investors were excluded for reasons of collinearity. – 2 nd one uses the natural log of assets under management to account for a potential decreasing importance of size on the decision to invest as size gets larger. Also, the interaction between type of institutional investor and size is analyzed to explore whether larger public pension funds behave differently than larger private pension funds. 24

25. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Table 8.4 Listed PE Part of Investment Mandate Model 1 Listed PE is a Variable Allocation over Time Model 3 Listed PE Investment Decision Depends on Whether Fund also has a Private PE Fund Model 5 Marginal Effectt-statisticMarginal Effectt-statisticMarginal Effectt-statistic Constant-0.879-2.563**-0.359-2.524**-0.212-1.446 Institutional Investor Characteristics Log (Assets Under Management)-1.518E-02-0.583-1.005E-02-1.027-1.822E-02-1.269 Family0.4571.5890.2191.0570.1360.581 Private Pension Plan0.6002.818***-0.053-1.044 Public Pension Plan0.2590.8300.0130.1260.0770.781 Bank0.5372.107**0.1480.5390.3321.107 Insurance Company0.5982.703***0.2760.8680.2631.308 Location UK0.3352.501**0.0931.1050.2891.839* Switzerland0.1921.2550.1261.1190.2241.243 Netherlands0.3641.929*0.2941.080 Finland0.2090.860 Germany-0.069-0.5090.0160.2510.0120.119 Sweden0.6014.467***0.7273.353***0.0430.284 Internal Investment Decision Making The Private Equity Team-0.022-0.187-0.012-0.2670.1041.036 Equities Team0.0990.3520.0030.0280.0740.450 The Alternative Asset Team-0.207-2.236**-0.047-1.4850.0080.082 The Board / Investment Committee0.0220.2200.0120.275-0.077-1.589 Consultant Advised of Listed PE0.1360.9610.0510.6860.0430.444 Beliefs of Decision Makers Listed Private Equity Offers More Liquidity than Limited Partnerships Listed Private Equity Allows Access to Private Equity Immediately 0.2532.849***0.2413.295***0.0621.460 Listed Private Equity Companies are Attractive to Invest After the J Curve 0.2092.377**0.0951.857*-0.026-0.589 Listed Private Equity Simplifies the Administrative Burden and Cash Flow Goodness of Fit Pseudo R 2 0.2180.4020.233 25

26. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Summary of Table 4 Findings (1 of 2) Introduction Theory Data Tests Conclusion Support for Hypothesis 1A – Private pension funds are 60% more likely to invest in listed private equity Relative to public European pension funds, private European pension funds have fewer individuals on the investment team, which makes the added due diligence and costs and time with limited partnership private equity much less attractive. – Furthermore, listed private allocations are less likely to be variable for private pension funds and larger private pension funds Support for Hypothesis 1B – Model 1 (Model 5) further shows listed private equity is 33.5% (28.9%) more common for institutional investors based in the UK 26

27. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Summary of Table 4 Findings (2 of 2) Introduction Theory Data Tests Conclusion Support for Hypothesis 2 – Relative to decisions allocated to an equities team, decision making allocation reduces the probability of investment in listed private equity by 20.7% when allocated to the alternative asset team (Model 1) Support for Hypothesis 3 – Institutional investors that use listed private equity to obtain access to private equity immediately are 24.1% more likely to have variable allocations to listed private equity over time (Model 3) – Model 3 also shows that institutions investing with a view to investing after the J- curve are 9.5% more likely to invest in listed private equity with a variable allocation, while Model 4 shows preference for simpler cash flow and administrative burdens are 17.3% more likely to have variable listed private equity allocations. 27

28. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Percentage of Listed PE versus other PE Model 8 Percentage of Listed PE Relative to Total Assets Model 10 Difference between Percentage of Target PE Allocation and Actual PE Allocation Model 12 Coefficientt-StatisticCoefficientt-StatisticCoefficientt-Statistic Constant-3.358-4.417***-3.481-7.138***-4.834-19.454*** Institutional Investor Characteristics Log (Assets Under Management)-1.713E-01-2.700***-1.279E-01-2.488**1.122E-014.287*** Family0.0350.074-0.093-0.4000.2891.406 Private Pension Plan-0.317-0.630-0.305-1.3530.0320.216 Public Pension Plan-0.297-0.612-0.267-1.163-0.154-1.112 Bank0.5621.0550.2851.081-0.653-3.218*** Insurance Company0.5971.372-0.090-0.458-0.329-2.163** Location UK0.4732.336**0.1411.923*0.2101.482 Switzerland0.7542.792***0.5252.273**-0.306-2.579** Netherlands0.7782.014**0.4832.664***0.0040.034 Finland-0.167-0.3280.0570.5190.3911.913* Germany0.1650.7580.1110.905-0.296-2.721*** Sweden1.4884.041***0.7472.912***0.0600.240 Internal Investment Decision Making The Private Equity Team-0.274-1.300-0.082-0.872-0.253-2.275** Equities Team-0.145-0.295-0.180-1.600-0.239-0.755 The Alternative Asset Team0.0390.1010.0940.691-0.349-2.733*** The Board / Investment Committee-0.008-0.039-0.059-0.489-0.262-2.272** Consultant Advised of Listed PE-0.102-0.459-0.156-1.476-0.221-1.964** Beliefs of Decision Makers Offers More Liquidity-0.085-0.361-0.148-1.385-0.069-0.546 Simplifies the Administrative Burden0.5953.726***0.2522.450**0.0280.289 Listed Private Equity Allocation Dummy=1 for Currently Invested in Listed PE-0.188-1.820* Dummy=1 for Listed PE Allocation Varies Over Time 0.4462.859*** Goodness of Fit Pseudo R 2 0.1010.1540.199 28

29. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Summary of Table 5 Findings (1 of 2) Introduction Theory Data Tests Conclusion Support for Hypothesis 1A – Larger institutional investors invest less in listed private equity relative to limited partnership private equity, Economic significance: a change in institutional investor size from €5 billion to €10 billion reduces the amount invested in listed private equity relative to total equity by 0.5% This is significant because the average amount invested in listed private equity versus limited partnership private equity is 2.83% and the average institutional investor in the sample manages over €35.5 billion Support for H2A – Models 7-10 provide similarly strong support for Hypothesis 8.1B for location in the UK versus continental Europe. – Also, the data indicate strong levels of investment in listed private equity in Switzerland, Sweden and the Netherlands. No support for Hypothesis 2 – Models 7-10 do not provide strong support for Hypothesis 8.2. Support for Hypothesis 3 – Allocations to listed private equity versus limited partnership are approximately 5% higher for investors that believe listed private equity affords access to private equity immediately 29

30. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Summary of Table 5 Findings (2 of 2) Introduction Theory Data Tests Conclusion How far away the institutional investor is from its target private equity allocation? – Strongest support for Hypothesis 3 Institutions that use listed private equity are approximately 5% closer to their desired private equity allocation relative to institutions that do not invest in listed private equity. – Additional evidence supports Hypothesis 1A Larger public pension funds tend to be farther away from their desired allocations to private equity, consistent with Hypothesis 1A – Additional evidence supports Hypothesis 2 Allocations made by an equities team tend to be closer to their desired private equity allocation 30

31. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Introduction Theory Data Tests Conclusion Summary and Conclusions 31

32. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Conclusions (1 of 2) Introduction Theory Data Tests Conclusion The public equity market’s expectations regarding current expected returns to investment in listed versus limited partnership private equity are not very attractive (Jegadeesh, Kräussl and Pollet, 2009). Worth exploring factors that affect institutional investor portfolio management and allocations to private equity, and in particular raises the question of how institutional investors allocate capital within different segments of the private equity market. We explore for the first time various factors that influence such capital allocation decisions to listed versus limited partnership private equity funds. 32

33. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Conclusions (2 of 2) Introduction Theory Data Tests Conclusion Size and type – Smaller institutional investors allocate capital to listed private equity, as do private (not public) pension funds, and those with a preference for liquidity and are based in the UK (not continental Europe). Decision making – The empowerment of decision making to an equities team has a pronounced impact for investment in listed private equity. – Where institutions allocate decision making to a private equity team, an alternative asset team, or the board / investment committee, investment in listed private equity is much less common. Institutions invest in listed PE to reduce search costs, and achieve a desired investment exposure in as timely a manner as possible. 33

34. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting Supplementary Issues with Listed Private Equity (1) Performance Measurement (2) Government Created Investment Schemes that look like listed PE 34

35. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting (1) Performance Measurement PE investments take a long time to exit in IPO, acquisition, secondary sale, buyback or write-off (2-5 years common) Valuations of portfolio companies infrequently change prior to exit, implying betas are low – See Chapter 22 for valuation methodologies – Listed private equity indices of performance are difficult to construct (http://www2.standardandpoors.com/spf/pdf/index/SP_Listed_Private_E quity_Index_Methodology_Web.pdf)http://www2.standardandpoors.com/spf/pdf/index/SP_Listed_Private_E quity_Index_Methodology_Web.pdf Fund managers have perverse incentives to over-value unexited investments to attract new funds from institutional investors (Chapters 4 and 22) 35

36. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting (2) LSVCCs are like Listed PE funds, but Not Canadian LSVCCs Labour Sponsored Venture Capital Corporations – Chapter 9 of this book – Tax-subsidized Venture Capital Funds – Investors are individuals, not institutions – Massive tax breaks for $5000 investments (RRSP eligible, plus 15% federal and provincial) – Statutory covenants that are inefficient, such as <2 year time limits to reinvest contributed capital Similarly, UK VCTs Venture Capital Trusts are not considered Listed PE by LPEQ 36

37. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting 37

38. © Cumming & Johan (2013)Venture Capital and Private Equity Contracting 38