US mid-market: niche strategies

While large-cap fund managers have been busy winning over LPs with diverse investment strategies, the same push for diversification has not been as strong among their mid-market cousins – until 2015 it seems.

Faced with an acquisition environment commanding top dollar for private equity buyout candidates in the US mid-market, some fund managers have focused on growing their portfolio companies or realising investments.

Others, however, have sought alternative avenues to generate diversified returns outside their core buyout areas: opting to follow the trails blazed by their large-market brethren with new strategies focused on diverse asset classes, speciality niches or geographies.

“While there’s a lot of dry powder in the mid-market, it’s divided into a much wider range of strategies than dry powder in the mega-fund sector,” says Antoine Drean, chief executive of fundraising marketplace Palico.

“That segmentation is encouraging investors to look at areas within the mid-market where there is relatively little dry powder. This helps explain the growing popularity of sector and niche funds.”

Some of the specialist funds that have come to market this year include: New York’s Riverside Company, which is raising money for its first $350 million debt fund, Strategic Capital Fund I-A; Connecticut’s Catterton Partners, which has launched a Latin America-focused fund with a $500 million target and a lower mid-market buyout vehicle; Z Capital, which is seeking $400 million for its Credit Tactical Opportunity Fund; and Alabama’s Harbert Management, which closed its first European growth equity and debt capital fund at €122 million in June.

“From the GP’s perspective it makes all the sense in the world. They are risk-mitigating their business by having a diversified stream of revenues and performance in different market cycles and asset categories,” says Jon Grabel, chief investment officer at the Public Employees Retirement Association of New Mexico.

The interest in specialist funds comes at a time when some fund managers in the segment have run into trouble raising traditional corporate buyout funds. Castle Harlan, for example, ceased fundraising in July.

Some managers have turned their attention to growth-oriented funds, says Rufus Whitley, chief investment officer at the Oblate International Pastoral Investment Trust, an LP which invests on behalf of more than 200 Catholic organisations and has about 35 percent of its assets allocated to private equity investment.

“Tactical growth funds that are a hybrid between buyout and venture are becoming more popular,” he says.

Buyout groups that are raising capital for US-oriented growth funds include California’s Shamrock Capital Partners, which is seeking $600 million for its fourth partnership, and Bertram Capital’s third fund targeting $750 million.

As long as buyout investing remains challenging, the welcoming of strategy diversification by limited partners should be good news to GPs since it enables fund managers to navigate different, and hopefully better, return avenues for investors.