In order to thoroughly analyze and compare fund performance based on their geographical scope, it is crucial to understand that the Private Equity market is vast and encompasses very different strategies. It is important to distinguish between the lower end of the market, mainly composed of primary investments, and the higher end of the market, where most secondary investments are found.
The operations in the upper part of the market are usually the most well-known. As mentioned earlier, most of these deals are secondary, meaning they take place between institutional investors- for example, purchases between private equity managers, takeovers, or the purchase of a business line by a private equity from a company that wishes to divest. The underlying assets traded in these transactions are usually of considerable size and are present in several countries.
On the other hand, the lower end of the market (Lower-mid Market or LMM) is mainly composed of primary investments. This would refer to purchases that take place between a private equity manager and the owners of a company, who are not institutional, but rather individuals such as the founder or their family. Often, these companies are SMEs or businesses with local operations, and the transaction represents the first contact between the company and institutional investors.
Therefore, we find two styles of private equity. While transactions between institutional investors are usually simpler and depend primarily on the financial elements of the deal, the acquisition of a family business often goes beyond mere economics and requires relational elements such as trust and personal identification between buyer and entrepreneur.
In line with the above, it is essential to put oneself in the place of the owners of these small businesses and understand the distrust they may feel toward institutional or unknown foreign investors. For this reason, local investors who make an effort to understand a business may have a decisive advantage over foreign institutionals in gaining a seller’s trust. In addition, dedicating time and effort to obtaining a local perspective comes with the advantage of understanding the local market and the cultural and legal dynamics that come with it. It seems reasonable to deduce that this competitive advantage of regional private equities leads to higher returns from these funds compared to pan-European funds, whose activity
and investment strategy is cross-border.
Figure 1: Regional managers tend to have stronger gross returns than pan-European funds.1.
Market analyses seem to validate the thesis presented.
However, we cannot ignore the fact that the advantage of regional funds is limited to primary operations and, therefore, to the lower part of the market (LMM). Given the differences discussed earlier between the type of transactions in the upper and lower segments of the market, it does not seem reasonable to extrapolate this thesis to the upper segments of the market. Not only are mid to large-cap companies more institutional in nature, but they tend to better understand the dynamics of private markets and may even have experience in foreign markets.
Having established that, in general, regional funds obtain better results than pan-European funds in the Lower-Mid Market, we return to the conclusion reached in the last newsletter: specialist funds usually offer better returns than generalist ones. It is worth noting that the advantages favoring regional specialists are less pronounced within the peer group of sector-specialist funds, however, suggesting that the two paths of “specialisation” enjoy similar perks of market knowledge and credibility. Investors seeking to allocate their portfolio accordingly, therefore, may find benefit in investing in specialist GPs of either variety.
Notes:
- Qualitas Insight – Realised transactions in the Qualitas Insight database from 1989 to 2020 (N=1155).