By Nathaniel Luce
Who: Berk Sensoy, Hans Stoll Professor of Finance, joined Vanderbilt in 2017. A former systems engineer for Lockheed Martin, Sensoy earned a B.S. in physics from Duke University and an MBA and Ph.D. in finance from the University of Chicago. He began his teaching career at USC’s Marshall School of Business before moving to Ohio State’s Fisher College of Business, with a visiting professor role at Duke’s Fuqua School of Business in between.
Sensoy’s research looks broadly at asset management; a lot of his work has focused on private equity and venture capital, but he’s also turned to hedge funds and mutual funds as well. “I like looking there, because you have both sides of finance—the asset pricing, with risk and return, and then the corporate finance side, which involves agency relationships,” he says. “Most of my work has been about trying to look at these fundamental issues in finance, in the context of various asset management settings.”
In Sensoy’s appraisal, his research interests fall in line with many in business school academia: examining readily accepted business principles and quantifying their accuracy. “Through research, we’re turning business practice from a collection of anecdotes and case studies into systematic lessons,” he says.
Through this practice of investigation of what he describes (humbly) as “simple stuff that people didn’t know,” Sensoy and his coauthors have uncovered new and important findings that quantify performance of companies, investors, and even management.
What he’s researching: Much of Sensoy’s research centers, in some shape or form, around performance, an idea that he believes to be the core tenant of financial research. “If you think about what aspects of finance people are interested in, they’re interested in value, determining it and trying to figure out what the right actions are to maximize it.”
Private equity, an investment space that has grown vastly over the last 10 years, has been a focal point of late for him. A recent paper measures institutional investors’ skill at making private equity investments. Using data on investments made from 1991 to 2011, Sensoy and his co-authors found that some institutional investors do consistently outperform their peers, to the extent that a one standard deviation increase in skill leads to a 1 to 2 percent increase in annual returns. The difference has declined over time, consistent with a maturing industry.
”There are some implications for how the institutions should think about the investment management teams they have,” he says. “On the one hand, skill seems to matter, at least historically. On the other hand, I expect private equity investment returns to become more efficient. It may already be there, to some extent; it’s just grown so much and has almost been commoditized.”
Another paper investigates whether private equity managers earn their fees, examining the relationship between compensation practices, incentives and performance. “There’s a lot of evidence in mutual fund literature that if you relate risk-adjusted performance to fees, you get a negative relationship; higher-fee funds underperform,” he explains. “We found that was not the case in private equity.” Managers that perform better are compensated better, and those that don’t are compensated less.
As the private equity market has grown, secondary markets have emerged to alleviate some of the illiquidity inherent in PE funds, which can take a decade or more to retire and offer little certainty in terms of capital flow timing. Sensoy and co-author Nick Bollen, the Frank K. Houston Professor of Finance at Owen, developed a model to help quantify the returns that private equity investors should require to compensate for liquidity risk in the presence of secondary markets. They find that empirically observed returns are generally sufficient, but not for institutions with less tolerance for risk or that cannot access above average PE funds.
In a separate paper, Sensoy has looked at prices and returns to buyers and sellers in the secondary market. The study findings implied that buyers outperform sellers by a market-adjusted five percentage points annually, underscoring the relative flexibility of buyers versus sellers. The secondary market is small—perhaps 2 percent of assets under management for private equity as an asset class—but significant. “PE is a big part of these institutional investor portfolios, so a market like that is important to understand, because they could want to get out for all sorts of reasons.”
On the hedge fund side, Sensoy has looked at managers’ indirect incentives. Hedge fund managers typically work under “2+20” contracts, where they earn 20 percent of profits as well as a 2 percent management fee, pegged to the amount of money managed. An additional source of incentives comes from the fact that when they do well, they typically get more money to manage, increasing fees. “The goal is to figure out the size of these two effects, how they compare to each other, and how they sum up,” he explains. “If a manager does a little better today, how much more money do they get from these effects?”
Historically, research has focused on the direct “20” as a source of incentives, so Sensoy and co-authors set out to determine whether the indirect piece was negligible. What they found wasn’t negligible at all. “The total pay for performance is much larger than it looks like if you look at the direct profit sharing piece alone,” he says. “These managers are much more strongly motivated than you would think.”
Sensoy hasn’t just evaluated investor performance, he’s also looked at management and company performance. In a paper partially titled “Should Investors Bet on the Jockey or the Horse?” Sensoy and his co-authors studied the relationship between management turnover and company performance, looking at 50 venture capital–financed firms. They found that, at the margin, startup investors should place more weight on investing in a strong business than on a strong management team.
What he’s teaching: This year, Sensoy will be teaching a new course for Owen, Investments and Entrepreneurial Finance. The course will focus on venture capitalists, angel investors, crowdfunding and strategic alliances, as well as what makes a sensible business idea, barriers to entry, and even how to cash out of a successful business.
“A big theme in Entrepreneurial Finance is that funding isn’t just money,” he explains. “It’s money plus help and advice; what types of non-money inputs do you need?”
Sensoy believes that entrepreneurship is a key component of business school education, for those seeking to launch a venture or work at a large organization. “In some ways, you’re always an entrepreneur. You are your own business; your work and reputation carry with you,” he says. “I think everyone should take Entrepreneurial Finance.”
Entrepreneurial Finance will be a case-based course, as will Investments, a course that’s traditionally taught out of a textbook. Sensoy will bring his extensive investment-related research to bear for students. “It’ll be fun for me, and I think it should be fun for the students. That’s the goal, and I’m really looking forward to it.”
For Sensoy, Vanderbilt felt like the right next step in his career. “I can have an impact here, with teaching and research,” he says. “Nashville is a really booming town, and Vanderbilt is an elite institution, not only in business. This is a place where a lot of people want to be. It’s a great opportunity for me to be part of a great institution.”