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Replicating Nordic private equity : capture private equity return and risk in the Nordic stock market

Fladvad, Henrik; Tvedt, Jørgen
Master thesis
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URI
https://hdl.handle.net/11250/2683681
Date
2020
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  • Master Thesis [3375]
Abstract
Private equity is widely known as an asset class delivering highly impressive returns. Still,

critics like to point out the excessive fee structure in the industry. This paper investigates

whether a passive stock portfolio, mimicking the asset selection and leverage level of private

equity funds, to a lower cost can emulate the risk and return yielded by Nordic private equity.

We find that buyout funds have a tilt towards selecting relatively small firms within specific

sectors of the economy. Further, we find that buyout targets tend to be relatively more

leveraged, relatively more capital-efficient and to have a relatively lower asset growth turnover

than comparable Nordic stocks.

Overall, two of our 24 characteristics-matched and leveraged-matched replicating portfolios

offer returns that exceed the attractive returns yielded by Nordic private equity in the period

June 2006 to June 2018. A five-year buy-and-hold portfolio, selecting stocks based on size,

sector, EBITDA and asset growth turnover, yielded an annualised excess return of 18.6% in

the investment period, outperforming the pre-fee private equity return of 17.2%. After

accounting for fees and transaction costs, 13 of the 24 replicating portfolios earned a higher

return than the benchmark.

However, none of the passive replicating portfolios can reproduce the risk-adjusted return of

private equity. Our analysis indicates that the lower risk of private equity may be explained

by i) the active management approach, ii) beneficial interest rates and loose covenants of their

long-term corporate debt, and iii) the existence of return smoothing. Nevertheless, we

conclude that a replicating portfolio offers a cheap and accessible investment strategy for

investors that deny paying the excessive fees of private equity and can accept large fluctuations

in portfolio values.

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