Research from Cambridge Associates, the global investment firm, shows that investments by sector-specialist private equity funds outperform those made by generalist private equity funds by 4.7 per cent.
For investments made from 2001 to 2014, the average Internal Rate of Return (IRR) on investments made by private equity funds focused on a single sector was 22.6 per cent, compared with 17.9 per cent for investments made by generalist private equity funds.
When comparing returns for investments made in a single sector by a specialist fund with those made by generalist funds, the outperformance of specialists holds. As seen in the graph below, the sector where specialists have had the strongest outperformance is healthcare, where average IRR of investments by specialist funds was 34.4 per cent, compared with 19.2 per cent by generalist funds.
According to Cambridge Associates, sector specialists have a depth of knowledge that informs their investment strategies in areas such as: sourcing the right investment without having to enter an auction process; pricing acquisitions; adding value through operational improvements; and sourcing a trade buyer for an exit.
Andrea Auerbach, Global Head of Private Investments at Cambridge Associates, says: “Making operational improvements to a business, shifting its strategic focus, scaling it up – these are not easy things to do. Having sector expertise should give a better chance of success.”
“Sector specialists argue that they have the ability to identify investment opportunities and value businesses accurately. By being closer to the industry and the people in it, they should theoretically be better able to identify the trends and themes that will drive future growth.”
Sector-specialist PE managers should be able to use their long-standing personal relationships within their sectors to source more attractive and differentiated investment opportunities, some of which may not be available to others in the market.
Their expertise in identifying risk factors in their sectors may also mean they are able to avoid more marginal investments – something that is a key factor in delivering outperformance.
Auerbach adds: “All of the advantages in sourcing and operating businesses help lead to higher returns over time, making sector specialists worthy of consideration by investors.”
