Limited partners must be willing to consider backing first-time funds if they want to capture the best returns. This was the message to delegates at the BVCA Summit 2016 from Cambridge Associates’ Andrea Auerbach, managing director and head of global private investment research.
“You need to be willing to make room for new funds,” Auerbach said. “New funds have a lot of reasons for being, they’re very aligned with returns, they’re focused, they’re hungry, and they clearly are showing up in the winner’s circle.”
Cambridge Associates data show that 40 percent of the top five performing European private equity funds across vintages, based on net TVPI multiple, were first or second-time funds. Eighty percent were funds one to four, with just 20 percent more established fund managers investing their fifth or later fund.
Conversely, 34 percent of the bottom five funds across vintages are first or second funds, 40 percent are third or fourth funds, and 26 percent are more established funds.
“As an investor, you’re always trying to keep an eye on the bottom half of the distribution,” Auerbach said. “We think it’s very important to maintain and refresh selections from a fund investment standpoint.”
Cambridge’s data also show that specialised funds perform better than generalists in the same sectors. For example, healthcare-focused funds were delivering a multiple of invested capital of 2.2x and an internal rate of return of 25.1 percent as of 31 December 2013; generalist funds investing in the healthcare sector achieved a MOIC of 2x and an IRR of 17.3 percent.
Overall, sector-specific funds outperformed generalists by 570 bps. As well as offering higher upside potential, sector-focused funds lose less money than generalists; Auerbach’s analysis showed 30 percent of generalist firms were delivering an MOIC of less than 1x at 31 December 2013, while fewer than 25 percent of funds focused on either the consumer, financial services, healthcare, or technology sectors were delivering less than 1x.
Auerbach noted that sector-specific funds tend to be both smaller and newer than generalist funds. One of the tensions LPs have is the need to reduce manager relationships, which often leads them to back larger managers with a generalist approach.
“You may be potentially leaving some significant return on the table, as many of the firms that are focused in these sectors are below $1 billion in size.”