How to Calibrate the Risk of Buyout Investments? Through Buyout-Backed Initial Public Offerings

Volume 15, Number 4, 2017
Jean-François L’Her, Ram Karthik and Stéphanie Desrosiers

This paper proposes to use the public market returns of buyout-backed initial public offerings (BO-backed IPOs) as a proxy for buyout funds’ appraisal-based returns. Because they provide an economically significant route to exit, and their leverage and fund ownership are still significant three years after the IPO, they represent unique public candidates to directly assess the risks of buyout investments, and to circumvent the stale pricing issue inherent in appraisal-based returns. Our sample covers the 1980–2013 period, and comprises 1,063 BO-backed IPOs. Our risk factor analysis shows that the market betas are close to 1.2, and the loadings on size, value and liquidity are significantly positive. Further, the loadings on the Fama and French profitability and investment are both significantly negative. These results can guide the calibration of the expected return and risk of buyout investments in strategic asset allocation: beyond exposure to Large Cap Equities, approximately 40% of the risk and return of BO-backed IPOs is explained by additional exposure to the market, and exposures to risk factors.