Small cap LBO funds are more profitable than funds that focus on target companies of larger market capitalisation, according to new research from eFront. In addition, small cap funds deploy capital at a faster rate and reinvest a significantly higher proportion of fund sizes than other funds.
They also continue to invest significantly until year eight of the fund cycle, against a normal investment period of five years, and distribute capital much earlier than medium, large and mega cap LBO funds.
Given these findings, it could be tempting to conclude that smaller cap LBO funds are more attractive than large and mega cap funds when looking at distributions. However, knowing that capital contributions are also significantly higher, and that capital might be significantly recycled, the overall picture is more nuanced.
Indeed, if mega cap LBO funds seem less profitable, they also have attributes which might make them appear as less risky. In particular, they provide predictable streams of cash flows. Contributions are essentially limited to the first five years of activity of the fund and distributions are largely done by year ten. Given these attributes, patient investors that are willing to handle greater risk and more fluctuations in terms of capital inflows and outflows might better suited to looking at smaller cap LBO funds.
Tarek Chouman, CEO of eFront, says: “The debate surrounding the performance of US LBO funds and its expected evolution can at times hide a more nuanced and granular perspective. Looking at the funds according to the size of the transactions they operate at introduces an interesting perspective. Notably, it is clear that mega LBO funds are not representative of the overall LBO sector.
“Cash flow patterns uncover a wide diversity of activities, and counter-intuitively show that small cap LBO funds are extremely active in recycling capital and are likely to operate significant buy-and-build strategies. This shifts the debate to investor preferences and their perception of how adequate the return profile of each category of LBO funds is. Breaking down LBO funds in categories also hints at different risk profiles. This supports a more balanced view of the merits of each category of LBO funds.”
