This circumstance requires limited partners (“LPs” or “Limited Partners”) , such as funds of funds, to identify the trends in each region in order to subsequently select the best opportunities among private equity managers (“GPs” or “General Partners”) whose investment focus is on strategies linked to the local economy. For example, when investing in a region like Italy, given the characteristics of its economy, it would be ideal to look for GPs that invest primarily in industrial companies or those related to sectors that lead the country’s economy, such as fashion or food, focused on exports. On the other hand, if the intention is to invest in the Nordic region, it would be advisable to seek private equities interested in companies related to software or technology, due to the strong investment in digitization in these countries.

Therefore, it seems reasonable to think that a significant portion of the results in the LMM egment are influenced, among other factors, by the performance on the real economy of the invested sectors. Consequently, strategies that invest in these sectors not only achieve better results but also assume lower risks.

However, what truly adds extra value to this conclusion, is to relate it to the findings from previous versions of the newsletter. For instance, in the chapter “Generalist or specialist funds?”, it was proven that, in general, specialist managers whose strategy focuses on investing in one or two industries that they are very familiar with and of which they know the insights, tend to achieve better returns than generalists who invest in a broader sectoral scope. As we saw on that occasion, this is mainly because these managers have more specific knowledge of the sector and environment in which their companies operate, facilitating both organic and inorganic value creation. At the same time, their experience and extra focus on those industries make specialist GPs a reference in their sectors, placing them in a preferred spot to reach the best opportunities compared to generalist managers.

Figure 1: Gross return (IRR and MoC) segmented by sector and fund type¹.

Furthermore, in the immediately following chapter “Regional or Pan-European Funds?”, we reached the conclusion that when investing in the LMM, it is preferable to do so in regional funds rather than pan-European ones, as the former tend to generate better results mainly due to two factors: i) negotiations in the LMM go beyond strictly financial aspects since owners are rarely institutional, so they tend to sell and offer the best opportunities to local investors who are familiar with customs and with whom they feel more connected, and ii) local GPs often have a better understanding of the real economy in their respective regions, as well as the role of their companies within it. This greater exposure also means that they become aware of regional trends earlier compared to international investors, who take longer due to their lack of direct contact with the market.

These two points can be supplemented with other important factors, such as being more adept at dealing with legal aspects intrinsic to the region, which has proven to be crucial in structuring acquisitions and devising strategies in countries like Denmark, where a particularly aggressive tax treatment on dividends leads to using more leverage than in other countries. This specialized country-specific vision usually enables managers to achieve superior results.

Figure 2: Regional managers tend to have stronger gross returns than pan-European funds².

As we can see, the conclusions from previous versions of the newsletter align perfectly with the idea presented in this one, which is to focus investment on managers who adapt their strategies to the real economy of the region. In this way, it seems reasonable to think that investing in local managers who specialize in key sectors of their respective regions’ economies opens the door to maximizing profitability and minimizing risk.

Having a pan-European vision with detailed knowledge allows for the selection of specialized strategies that work in different markets. In upcoming chapters of this newsletter, we will present examples of winning strategies in various economies.

Notes:

1. Gross returns on Cambridge Associates US Buyout and Growth Equity benchmark (vintages 2001-2015). Source: Cambridge Associates LLC Private Investments Database.
2. Qualitas Insight – Realised transaction in the Project Insight database from 1989 to 2020 (N=1155).