Measuring Risk for Venture Capital and Private Equity Portfolios

For alternative assets such as venture capital, buyouts (private equity), real estate, etc., the standard regression of portfolio returns on market returns to measure risk produces risk measures that are not credible. Institutional investors, doubting such measures, instead often use either some rule of thumb, such as a stock market index plus a premium (S&P500 5, or Russell3000 3) as a benchmark, or attempt to evaluate portfolios using public market equivalents. This paper shows an alternative approach to measuring risk directly which explicitly addresses the staleness of reported values for venture capital (and other alternative assets) by including lagging market returns in the regression to capture the full relatedness of portfolio returns to market returns. Examples for venture capital and buyout portfolios show that the true risk measures are generally more than double those from naive measures lacking lagging market returns. The measurement also reveals the staleness profile of each portfolio, which can be used to calculate a mark-to-market value for the portfolio.