A Decision Making Framework for Portfolio Selection in Private Equity Investments
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A Decision Making Framework for Portfolio Selection in Private Equity Investments Tim A. Herberger 1,2 & Felix Reinle 1
# International Atlantic Economic Society 2020
JEL Classification G30 . G10 A method is proposed for multicriterial (pre-)selection, analysis and ranking of portfolio companies from the perspective of a private equity (PE) investor using Data Envelopment Analysis (DEA). The result is a relative ranking of portfolio companies, with all portfolio companies serving as a peer group. The problem of systematically and intersubjectively selecting a comprehensive PE portfolio has received little attention. Traditional models for portfolio selection and management are difficult to implement. For example, Markowitz portfolio theory (Markowitz, The Journal of Finance, 1952) is basically not applicable due to violation of almost every required assumption. Furthermore, historical data on cash flows, returns and volatility are often neither available nor accessible to the potential investor for privately traded equities, in contrast to publicly traded securities (asymmetric information problem). In addition, the investment goals of highly specialized PE investors may differ just as much as the criteria they use for screening and selection. In order to effectively address these PE portfolio selection problems, a portfolio selection and management model should consider individual, non-monetary and multidimensional selection criteria as well as heterogeneous objectives. The proposed model is intended to fill this gap in the literature. This tool will enable a systematic and intersubjectively comprehensive solution for selection problems with heterogeneous, multidimensional and PE-individual
* Felix Reinle f.reinle@zeppelin–university.net
1
Chair of Entrepreneurship, Finance and Digitalization, Andrássy University, Budapest, Hungary
2
Research Fellow, Department of Finance, Bamberg University, Bamberg, Germany
Herberger T.A., Reinle F.
selection criteria, without requiring unrealistic assumptions about available data. The core-element of the proposed approach, DEA, was originally conceived for efficiency valuation and not for selection (Charnes et al., European Journal of Operational Research, 1978). “Misappropriation” of DEA for selection purposes enables consideration of individual, heterogeneous and multidimensional decision criteria in the screening process by the investor and in portfolio selection. No assumptions are required about the relative importance of each selection criterion, as compared to other multi-criteria-decision-making (MCDM) approaches. Weighting and assumptions about the relative importance of each criterion are not necessary, as they are part of the functionality of DEA. This unique feature of DEA methodically reflects the high uncertainty that can accompany PE investments. Use of DEA’s relative efficiency assessment for selection purposes is novel in the PE context. However, in portfolio management in research and development, as well as in project selection (project management)
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