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In Private Equity Funds, Does It Really Pay to Diversify?

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The majority of buyout funds over the years have had a diversified investment focus in terms of both the number or funds raised and the aggregated capital secured, according to a new analysis of fundraising data by Preqin, the alternatives data provider.

Preqin found, however, that many investors thought a manager with deep knowledge of a specific industry would make better-informed investment decisions, leading to superior performance.

Performance is critical, as many investors looking for a new fund manager list the general partner’s past performance as their chief criterion.

Preqin reported that 37% of investors in a survey listed past performance as the most important factor in assessing a new manager.

Diversified vs. Sector Specific

Is there a difference between the two approaches?

Preqin researchers compared performance of diversified and sector-specific funds by examining 1,690 buyout funds with vintages from 1982 to 2012.

Twenty-nine percent of sector-specific funds ranked in the top quartile, compared with 24% of the diversified buyout funds.

“While no guarantee of future performance, this analysis shows that those fund managers that exclusively target one industry have historically been more likely to achieve top-quartile returns,” Preqin said.

But individual industries matter, Preqin found, as sector-specific funds produced mixed performance.

Some industries generated superb track records, with significant proportions of funds performing extremely well, or only a minority of funds falling into the bottom quartile.

Telecoms, media and communications and information technology were star performers. Thirty-three percent of funds focused on TMS and 32% focused on IT landed in the top quartile, and just 13% of IT-focused funds fell into the bottom quartile.

In contrast, 32% of buyout funds focused exclusively on health care wound up in the bottom quartile, and 24% in the top quartile.

Preqin found that earlier vintages of diversified funds had a higher median net internal rate of return, but that the trend reversed in 2005.

Most recent data for vintage 2012 funds showed a considerable difference between the two fund categories, with sector-specific buyout funds maintaining their performance edge.

Looking Ahead

Preqin statistics showed a continued bias for diversified funds. At present, 227 funds are trying to raise $202 billion in aggregate capital.

Only 39% of buyout vehicles, representing 26% of all capital sought, will invest in only one industry.

Preqin noted that as investors’ appetite for sector-specific funds has increased, separate account vehicles have become more prominent.

It cited as one example the New Jersey Division of Investment’s $150 million commitment in the NJ/HitecVision co-investment vehicle, which explores opportunities in the oil and gas sector.

Following are the biggest sector-specific and diversified buyout funds seeking to raise capital, according to Preqin data. 10 Largest Sector-Specific Buyout Funds in Market

Sole Industry Focus

Charterhouse Capital Partners X (Europe), $3.4 billion—Consumer discretionary

Welsh Carson Anderson & Stowe XII (U.S.), $3 billion—Healthcare

Blackstone Strategic Capital Holdings (U.S.), $3 billion—Business services

Dyal Capital Partners III (Neuberger Berman—U.S.), $2.5 billion—Business services

Lion Capital Fund IV (Europe), $2.5 billion—Consumer discretionary

KSL Capital Partners IV (U.S.), $2.3 billion—Consumer discretionary

Foundation Capital Partners (U.S.), $2 billion—Business services

Yucaipa American Alliance Fund III (U.S.), $1.6 billion—Consumer discretionary

AnaCap Financial Partners Fund III (Europe), $1 billion—Business services

Aquiline Financial Services Fund III (U.S.), $1 billion—Business services


10 Largest Diversified Buyout Funds in Market

Blackstone Capital Partners VII (U.S.), $17.5 billion

TPG Partners VII (U.S.), $8 billion

EQT VII (Europe), $7.6 billion

Georgian Co-investment Fund (Europe), $6 billion

Carlyle Long Life Fund (U.S.), $5 billion

RRJ Capital Master Fund III (Asia), $5 billion

Lindsay Goldberg – Fund IV (U.S.), $4 billion

TA XII (U.S.), $4 billion

Russia-China Investment Fund (Russian Direct Investment Fund—Europe), $4 billion

CVC Strategic Opportunities Fund (Europe), $4 billion

— Check out Is Portfolio Diversification Overrated? on ThinkAdvisor.


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