Buyout funds/AI: robotic word nerds may make LPs better investors

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“TLDR” stands for “too long, didn’t read”. This damning shorthand is what many prospective private equity fund investors think as they skip through fund bumf.

Artificial intelligence programmes suffer no such fatigue. New research from Oxford university’s Saïd Business School claims that robots can spot buying signals in fund documents that human investors ignore.

Limited partners — the external investors that back private equity funds — have a tendency to focus heavily on quantitative data, such as past performance. But Ludovic Phalippou, one of the researchers, says that qualitative factors identified by AI can account for a 25 per cent spread in performance between the highest and lowest terciles in a spread of funds.

LPs need all the help they can get. Buyout funds recently posted their worst return since the global financial crisis, down 9 per cent in the nine months to September 2022, according to McKinsey. Fundraising fell more than 15 per cent during 2022 to $655bn.

External investors favour prominent general partners, the executives who select and manage stakes in companies. PE megafunds worth more than $10bn each took an increased share of fundraising in 2022. Yet fundraising success means little for future performance, the research suggests. Prospective LPs might get more from reading prospectus strategy sections, which average 2,633 words each. These contain useful information on each fund manager’s investment style.

The researchers used natural language processing, which seeks giveaway words and phrases, to trawl through prospectuses for funds launched since 2003. Variabilities apparently correlated with past fund performance.

The authors do not go so far as claiming that qualitative data predicts performance. Nor does their paper state what language rates as a screaming buy signal. However, it does point to the potential usefulness of AI in screening prospectuses.

Uncharismatic GPs should take comfort. Robots could, in future, save their prospectus from a premature encounter with an LP’s bin.