Part I: Deconstructing Value Creation - Alpha vs. Beta

Accounting for Market Beta to Identify Repeatable Value Creation

Author

Matthew Podlesak
June 18, 2024

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Question: What is our primary goal when investing into private equity funds?

Our Answer: Identify managers with a demonstrated and repeatable track record of driving value creation.

TLDR: ask these questions

Does the GP have a repeatable value creation playbook that they actively implement in their deals?

Is there a track record of the GP:

i) identifying these opportunities in their investment process and

ii) actually executing on these opportunities during the investment period

How much of a GP’s track record can be attributed to “market beta”?

There are three (3) primary areas where value can be extracted in a private equity deal.

1) Market Beta

  • Value created by positive shifts in the market that are not attributable to the GP’s initiatives

    • e.g. secular revenue tailwinds lifting an entire sub-sector… helping both the portco and their peers

  • For Generalist GPs:

    • does the GP deploy capital to the right sub sectors in a given market environment?

  • Sector Specialist GPs:

    • the ball is the LP’s court to pick the right sector specialists

2) Type 1 Alpha: Executed Value Creation Playbook

  • This is the most important lever that we are looking to identify

  • Goal: identify repeatable value creation playbook that the GP implements

  • Ask: what opportunities did the GP identify during the investment process?

  • Measure: how did the GP execute on those initiatives and what value did they create?

3) Type 2 Alpha: Unexpected / Opportunistic Value Creation

  • Driven by the GP’s ability to opportunistically identify and execute on unexpected value creation initiatives

  • The goal here as an LP is to understand when the GP has unique capabilities, resources, strengths that position them to capture these opportunities next time…

  • …and to know the difference of which GPs “got lucky” and had one-time windfalls that are not repeatable / can’t be underwritten

Stay tuned for Part II…

Breaking Down Market Beta and GP Alpha Across Specific Value Creation Levers

To preview our next post on this topic…

  • Understand where the GP generated Alpha vs. where Market Beta drove returns across the main value creation levers…

    • e.g. multiple expansion, revenue growth or margin expansion that exceeds those of the portco’s peers over the investment period