Following in the footsteps of their US counterparts, an increasing number of European funds are relying on their sector specialism to differentiate themselves from other funds in market.
Funds offering a sector specific strategy that have landed on the desks of London-based placement agents recently include those focused on sport, leisure, TMT, business services, healthcare, energy, asset-light technology, software, retail, food and beverage, and financial services.
London-based healthcare specialist GHO Capital Partners is a case in point. The firm was established in 2014 and is just €100 million off its €500 million target for its debut fund and still collecting commitments. In mid-October it announced its first acquisition, a €104 million investment in US-based DNA Diagnostics Centre.
The argument for sector differentiation is clear. Funds attuned to their target industry can boast superior market knowledge and the ability to source exclusive deals, as well as develop investments and exit at the right time, avoiding the mistakes of a more generalist vehicle scanning a broader opportunity horizon. And more so if that sector is poised to grow.
Crucially, in a pricey market, specialist funds promise above average returns. “There is an expectation that these funds will be able to generate better returns in an environment that is increasingly competitive,” says Adam Turtle, partner at placement agent Rede Partners.
This should all be attractive to investors. Financial services restructuring specialist Cabot Square Capital appears to prove it. Its fifth fund raced to a first close in June at £300 million ($464 million; €410 million) after only six months in market and it is not seeking to collect any further commitments.
But there are risks. Funds limited to one sector are subject to its market cycles. Consumer-driven sectors such as retail can be volatile. And this is exacerbated in Europe by some sector funds’ country specialism.
Unlike the US, Europe is not a single market. There are variant economic dynamics, as well as divergent regulatory regimes. For sector funds, which are typically smaller in terms of capital and management teams and can lack a pan-European bandwidth, specialisation can also force them into a single geography concentration.
Other challenges to the GP are the increasingly narrow focus of some large generalist funds to a handful of key industries. Pan-European buyout firm Cinven, for instance, has a track record of healthcare acquisitions and exits. Its latest was the sale of its pharmaceuticals platform AMCo for an enterprise value of £2.3 billion in September.
This overlap begs the question why a limited partner would go to the expense and effort of investing in a number of individual sector funds if that diversification can be met with a single commitment?
The answer is two-fold. LPs with record distributions burning a hole in their pockets have the cash to invest beyond their usual menu of generalist funds.
“Investors are looking for interesting new strategies, and to commit to funds that are different to what they already have, and not just to invest bigger cheques into their existing portfolio,” says Monument Group managing director Janet Brooks. “They are looking to add new relationships.”
And marrying another trend, Brooks adds that some LPs are developing a taste for co-investments in specific industries and are actively seeking out sector specific funds as they search for deal flow.
With LP demand, more sector funds can be expected to follow.