It’s a long-held belief in the private equity community that first-time funds tend to produce the best overall returns, but if investors want to participate they must get comfortable with the higher risk attached.
However, data from CEPRES show first-time funds are not the top performers – nor are they the most risky bet for LPs.
Analysis of around 4,700 investments made by 444 buyout funds from 2009 to 2016 found second -generation funds typically have the highest level of performance on a gross pooled IRR basis, delivering 27.8 percent, compared with 26.1 percent for debut funds and 24.3 percent for fund three and beyond.
Those higher returns also come with more risk. Second-generation funds had higher loss rates – 7.7 percent versus 5.1 percent and 6.2 percent for first generation and third generation and beyond, respectively – and lower recovery rates, a gap of more than 25 percent in the case of debut funds.
GPs manage first-generation funds in the most risk-averse fashion, pushing up the risk curve for their second vehicle before stabilising somewhere in the middle, the CEPRES analysis states.
“The evidence shows that new buyout funds overall make better risk-adjusted returns than mature managers, and in particular the high recovery rates for deals are very impressive,” says Christopher Godfrey, president of CEPRES.
“On the second funds we see a move to more aggressive returns and higher upside performance with an increased risk profile which tends then to settle down into a more balanced risk/return spectrum by Fund Three and later.”