One of the surprising (to the author) outcomes of the dislocation in private markets over 2022 was a gravitation to what is referred to as ‘quality’. Typically, this refers to the large well-known providers. To the author this is akin to being in an abusive relationship. Many of these ‘quality’ names have raised huge funds over the last few years and have struggled to deploy the capital raised. Also, a lot of this capital (not all) has been allocated to leveraged buy-outs.
This is not to say there are not many good ‘quality’ providers but to gravitate to ‘marquee’ names may not be a wholly sensible wealth creation strategy. In our experience the smaller providers tend to operate in less competitive environments, the capital raised is digestible and they are focused on value creation not asset management fees. These funds also have the flexibility to move into new spaces as the market dislocation provides good ‘value’ and ‘special situations’ opportunities.
These characteristics provide a following wind to wealth creation. As such our Fund Philosophy has led us to focus on the smaller and medium sized (the boutique sector) funds. The additional advantage for investors with smaller tickets is that they are valued by the fund and are not just a third decimal point nuisance.
The study provides evidence that not only have smaller and mid-sized private equity funds outperformed their larger counterparts but they have a number of other inherent characteristics that provides confidence that this historic out-performance can persist.
Schroders Capital’s extensive research, encompassing data from over 49,000 private equity firms and 200,000 transactions spanning buyout, growth, and venture capital from 1980 to 2022, sheds new light on the performance of smaller funds. The study classifies small funds as those under $500 million and mid-sized funds as those under $2 billion.
A key finding is the superior performance of smaller funds
Between 2000 and 2017, small to medium-sized funds reported an average net Internal Rate of Return (IRR) of 16.9%, surpassing the 16.0% average of larger funds. They are also more resilient in that they maintain their outperformance persists in times of economic stress.
The study attributes this success to several different factors. Firstly, the dynamics of fundraising and deal entry multiples in the small- and mid-sized segment are more favourable. Large funds, experiencing an influx of capital, face heightened competition and higher entry multiples for deals. In contrast, smaller funds, with more digestible fund raises, are not subject to the same competitive pressures and can invest with more attractive investment multiples.
Additionally, smaller funds offer a broader spectrum of investment opportunities, often overlooked in the rush for large-scale deals. They also present more potential for operational value creation, making them appealing targets for larger funds or strategic buyers.
The data challenges the conventional wisdom that bigger is better in private equity
As large funds grapple with an abundance of capital and competitive deal environments, smaller funds emerge as potent avenues for diversification and robust returns, especially during periods of economic uncertainty.
This content is for information purposes only. Treble Peak does not provide investment or tax advice, and information on this website should not be construed as such. Potential investors should seek specialist independent tax and financial advice before investing in any alternative investment. Past performance is not a reliable guide to future returns. Your capital is at risk.