Private equity markets are highly cyclical. The aggregate amount of capital committed to the sector varies substantially from peak to trough, and many have observed that periods of high fundraising activity are followed by periods of low absolute performance for the asset class (see Harris, Jenkinson, and Kaplan, among others). This raises an important question: is it possible to market-time the allocations to private equity to avoid the cyclicality of performance?
While this question is of immense practical interest to the investor community, it also reflects the deeper economic forces at work in the sector. Creating time-varying exposure to the asset class is potentially complicated by two sets of agency frictions that are especially important in this institutional setting. The first potential agency friction arises inside the organizational structure of the investor (the limited partner, or LP, in the fund) itself. LPs can suffer from internal agency problems that prevent them from committing to so-called `disciplined’ capital allocation strategies. A second potential friction arises from the nature of delegation in the asset class. Unlike public markets in which assets (e.g. stocks) can typically be purchased or sold almost immediately, limited partners who commit capital to private equity funds face significant delays and uncertainty surrounding the timing of purchases and sales, which are controlled by the general partner (see Gredil; Robinson and Sensoy). Consequently, there is substantial ‘commitment risk’ when the investor has pledged capital but does not control the timing of when the money is put to work or returned.
