Predictive power
Florencio Lopez-de-Silanes, professorof finance at SKEMA Business School, agrees. He is a co-author of ‘Would I Lie to You?‘, a new academic paper on the qualitative information contained in interim reports. “Our research adds to a body of academic literature that highlights the limitations of interim valuations,” he says. The paper does show a positive association between interim valuations and final performance. However, it finds that interim valuations are a relatively weak predictor of how performance will change from interim to final.
The task that LPs face is further complicated by the paper’s finding that there is a clear spectrum of how aggressive GPs are in their valuation methodology. Indeed, this reveals some pronounced geographical differences. “We found that interim valuations appear to be more conservative in Europe, with a closer correlation with future performance, compared with the US, where the association between interim valuation and future uplift is actually negative,” he says. “Investors need to be aware that not all managers present their figures in the same way.”
The financial metrics provide a hint of where things are heading, but the real picture comes from everything else that is said. In private markets, it is impossible to form a prediction based on numbers alone.
Sven Czermin, Palladio Partners
Meanwhile, perhaps unsurprisingly, and in line with findings from previous studies, the research shows that underperforming GPs are particularly inclined to inflate the interim performance during periods of fundraising, meaning that the figures are at their most unreliable at precisely the time that LPs need accuracy the most.
It’s a pattern that Scopelliti recognises all too well. “Interim valuations tend to understate the true exit values shortly before realisations,” he says. “That’s because GPs tend to be conservative outside fundraising windows. But then there is an incentive for them to overstate the performance around fundraising periods.”
Czermin agrees. “There is an incentive for GPs to put their portfolio in a positive light during the fundraising process, particularly right now, when fundraising conditions are tough,” he says. “We see managers increasing valuations before launching a new vehicle and the reality is that at least some of them have the latitude to do so.”
There has been extensive research examining the informational value of PE interim valuations, but there has been little analysis of the accompanying qualitative disclosures. This is a gap that Would I lie to you? On Private Equity Intermediary Performance Reports aims to fill.
The research was carried out by Borja Fernández Tamayo (Université Côte d’Azur, SKEMA Business School and Unigestion), Reiner Braun (Technische Universität München School of Management), Florencio Lopez-de-Silanes (Université Côte d’Azur, SKEMA Business School and the National Bureau of Economic Research), Ludovic Phalippou (University of Oxford, Saïd Business School), and Natalia Sigrist (Unigestion). It draws on a novel dataset of over more than 20,000 interim performance reports from 2,049 investments, including both quantitative metrics such as sales, EBITDA margins, and valuation multiples, and over 240,000 sentences of qualitative commentary, to provide richer insights into portfolio dynamics. The project was developed in partnership with Unigestion, the source of the raw data used, and SKEMA Business School, which provided funding.
Using LLMs, the research finds that the tone of the commentary included in interim performance reports is a reliable predictor of how investment performance could change from interim to final valuation. A positive tone is associated with a significantly higher realised multiple on invested capital (MOIC), even after controlling for an investment’s interim valuation and fund characteristics. Specifically, it finds that a one standard-deviation increase in measured optimism (equivalent to a change from a neutral tone to the average — moderately positive — tone) results in a 0.18x subsequent increase in MOIC. The same magnitude of increase in interim MOIC results in just a 0.09x subsequent increase in MOIC above the interim. Reporting tone is particularly informative during fundraising periods and, unlike interim valuations, tone consistently predicts final multiples across GP locations and deal regions.
