Jekyll & Hyde: When Experience Is Double-Sided

Robert Louis Stevenson's famous book, The Strange Case of Dr. Jekyll and Mr. Hyde, has something to teach to private equity fund managers. The experience accumulated by these funds is both an opportunity and a threat, a space to be explored but also a mental barrier. Experience can lead to superior skills, but in can also induce resistance to change and organizational inertia. The explanation is intuitive: one tends to readily accept risk-free changes that improve one's position, but tends to oppose risky changes of uncertain outcome. The more experience one has, the less is one's openness to potential change.

Our research study, Experience, Superstition and the Weight of Cognitive Load: Evidence from the Private Equity Sector, conducted within Bocconi's Croma research center, has looked ino the double-edged nature of experience. It analyzed 7,267 investments made by 256 private equity firms worldwide over the last 30 years. The study was made possible by the construction of the largest available database on private equity. The analysis shows that performance of the individual investment is negatively affected by the number of companies simultaneously held by the fund. Private equity funds have limited decision-making capabilities which need to be divided and allocated among the various investments in the portfolio. As the number of companies held grows, the quantity and quality of attention that is devoted to each investment decreases. The study also verified whether and how the fund's accumulated experience (the number of investments previously made) affects that capability of the fund itself to manage additional investments simultaneously. More experienced funds manage to reduce the adverse effects deriving from running more companies in parallel. Surprisingly, the analysis has revealed that the experience garnered by the fund is negatively correlated with the performance of each individual investment. These two findings show that if on one hand the experience of the fund contributes to limiting the negative effects of parallel investments, on the other hand it leads to rigid skills which are unresponsive to change. The research study also shows that funds with better past performance are those that are less able to manage parallel projects. This result could be consequence of superstitious learning: successful funds tend to overestimate their managing skills and underestimate the risks deriving from the simultaneous management of various companies.

The results on the role of experience should not be interpreted as evidence for the fact that more experienced funds have worse performance, and this for at least three reasons. Firstly, the level of analysis brought into each individual investment. Although as experience grows funds tend to select less performing investments, this does not necessarily lead to decreasing returns for the fund as a whole. In fact, more experience funds could develop better asset allocation strategies by investing a larger share of their capital in more performing investments. Secondly, more experienced funds could have a more prudent investment approach leading to less volatile returns that are more attractive for investors in private equity funds. Thirdly, like every statistical analysis, the study only explains the variance of the returns of individual investments and does not analyze the ability of private equity funds to overcome the inertia generated by experience. For instance, thanks to experience, funds could develop the specific skills needed to overcome internal resistance to change.