Private market funds: Big or small?

Investors are increasingly allocating to private markets, seeking potential attractive returns and diversification benefits. 

A common factor faced when designing private market portfolios is whether to bias towards larger, more generalist strategies or smaller, more specialised offerings. This question has become more topical as private market fundraising has increasingly gravitated towards larger funds in recent years. At the same time, a greater focus on investing in technology and innovation has led to rising interest in emerging sectors and therefore more specialist or thematic driven strategies.

Below is a high-level comparison of characteristics of the two different types of investment strategies. We describe them as broad market access (bigger, generalist) and thematic alpha (smaller, more niche).

To understand the difference in return profile, we analysed performance of private equity buyout funds with vintage years 2000-2018 using data from Preqin. We chose buyout as this is the asset class with the most data points. Fund vintages beyond 2018 were excluded where performance may be less stable. 

The analysis shows that on an asset-weighted basis, the average IRR were similar, but smaller funds have a much greater dispersion in returns while larger funds are more consistent. This makes sense. Smaller funds are expected to be less diversified – their size is likely to put a restraint on the number of assets they can hold. To offset this, they may be more biased to smaller investments which can increase exposure to higher-risk, earlier-stage companies. This could mean bigger hits but also bigger misses. 

We also carried out further analysis on the performance dispersion between concentrated and well-diversified portfolios. This time we looked at UK real estate funds and plotted their long-term performance against the number of properties they held. Unsurprisingly, more concentrated funds (towards the left of the chart) showed a broader dispersion in long-term performance versus more diversified funds, as well as higher volatility.

In this battle of big versus small, is there a clear winner? We don’t think so. It is all down to what the investor is aiming to achieve in terms of return, their risk tolerance and the types of assets they want to support. Other practical factors also need to be considered. A portfolio made up of niche strategies can demand greater internal expertise, governance resources and fee budget, compared to using generalist funds. In any case, given the complexity of investing in private markets, manager selection is critical regardless of type of strategy.