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Small is beautiful when it comes to PE investments, according to new report

Akina and Professor Oliver Gottschalg, HEC Paris and PERACS, have jointly release a research study analysing the fundamental drivers of risk and return in portfolios of private equity fund investments. 

The report’s findings reveal the superiority of an optimally diversified small/mid-cap portfolio strategy both in terms of return and risk. Additionally, our results demonstrate the outperformance of the small/mid-cap segment over the large-cap segment in private equity fund investments.
In the current low interest environment private equity has become an increasingly popular component of investors’ portfolios. Yet many investors still struggle with how to best implement their allocation to the private equity asset class. Investors need to make decisions regarding the design of their private equity portfolio, including choices about the number of funds, geographic focus and size of such funds. There previously has not been much reliable evidence on how these choices influence the risk/return characteristics of the corresponding portfolio.

The research is based on a comprehensive data set of 771 mature European and North American primary buyout funds covering fund vintage years from 1998-2007. Random portfolios have been created using Monte Carlo simulation methods to illustrate the risk/return properties of the resulting portfolios.

Professor Gottschalg concludes that also in the context of private equity: “the power of the diversification effect is evident and leads to a significant risk reduction in all researched sub-samples”. Marginal benefits of diversification however decrease with increased portfolio size. The optimally diversified portfolio, in which the diversification effect comes into play, contains about 15 funds.

In practice investors face resource and volume limitations both related to selecting the most promising funds and to how much money they can invest in small/mid-cap funds. Sizeable amounts, in particular, can often only be deployed in large funds. Spending comparable amounts in small/mid-cap funds forces investors to invest smaller tickets on average into such funds, eventually leading to a more diversified portfolio. The study confirms the outperformance of the small/mid-cap segment over the large-cap segment.

Dr Ralf Gleisberg, Partner of Akina, says: “The results of the study point to the superiority of an optimally diversified small/mid-cap portfolio over a concentrated large-cap strategy in private equity. This holds true in particular for European funds both in terms of return and risk.” To implement an optimally diversified portfolio Akina provides flexible solutions for different volumes and deployment needs.

The results of the research are confirmed as well when looking at European funds only. An optimally diversified European small/mid-cap portfolio is less risky than a concentrated European large-cap portfolio and performs better both in terms of average and peak returns.

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