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“TLDR” stands for “too long, didn’t read”. Many potential investors in private equity funds use this condensing phrase as they skip through fund documents.
However, artificial intelligence programs do not suffer from such fatigue. A new study from Oxford University’s Saïd Business School reveals that robots can identify buying signals in fund documents that human investors tend to overlook.
Limited partners, who are external investors supporting private equity funds, usually prioritize quantitative data, such as past performance. Ludovic Phalippou, one of the researchers, argues that AI’s identification of qualitative factors can explain a 25% performance spread between the highest and lowest terciles in a range of funds.
Given the recent downturn in buyout fund returns, with a 9% drop in the nine months leading up to September 2022, as reported by McKinsey, LPs require all the assistance available. Fundraising also experienced a decline of over 15% in 2022, reaching $655 billion.
External investors tend to favor prominent general partners (GPs), who are the executives responsible for selecting and managing company stakes. In 2022, PE megafunds worth over $10 billion captured a larger share of fundraising. Nevertheless, the research suggests that fundraising success does not necessarily translate to future performance. Prospective LPs could gain valuable insights by examining the strategy sections in prospectuses, which average approximately 2,633 words each. These sections provide relevant information about each fund manager’s investment style.
The researchers employed natural language processing, which involves identifying specific words and phrases, to analyze prospectuses from funds launched since 2003. They discovered patterns that correlated with past fund performance.
While the authors do not claim that qualitative data can predict performance, they highlight the potential utility of AI in screening prospectuses.
In the future, uncharismatic GPs may find solace in the fact that robots could save their prospectuses from ending up in an LP’s bin prematurely.
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