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Rising deal prices could erode performance of smaller funds: study

  • Why this is important: LP appetite for small and midsized buyouts is strong, but these deals may be losing their advantage

In the frothy environment, even small-to-midsized deals are more expensive, potentially hurting the expected outperformance of smaller funds.

That’s the upshot of a Hamilton Lane paper, “What’s Top of Mind For Today’s LP,” by Mike Koenig, chief client officer.

Small and midsized funds have been strong performers, the study said. But such funds transacted at higher multiples than large buyout deals for the past three years, the study said.

In addition, while LPs like small and midsized deals because of lower leverage, the debt-to-Ebitda gap with large buyouts is closing, Koenig said.

The average adjusted debt-to-Ebitda multiple was 5.5x for small and midsized deals, compared with 5.8x for larger deals at the end of 2017, the study said.

While the perception is that fundamental performance is easier to achieve in smaller companies, “this fundamental advantage is starting to cost more,” the paper said.

Strong performance

LPs’ desire for small and middle-market funds was driven by various factors including performance, control and leverage, the paper said.

Nearly 70 percent of all funds projected to be raised in the next 12 months are small and midsized pools, Koenig said.

U.S. small- and midsized funds have been a steady top-performing asset class, the study said. Pooled IRR by vintage years showed U.S. small and midsized funds produced an IRR of 15.5 percent for vintage year 2014, 14.5 percent for 2013, 18.5 percent for 2012 and 16.7 percent for 2011, the study said.

In contrast, pooled IRR by vintage years for growth equity steadily declined. Growth equity produced an IRR of 10.6 percent for vintage year 2014, down from 12.3 percent for 2013, 15.8 percent for 2012 and 16.7 percent for 2011, the study said.

Small and midsized funds outperformed the composite of all private-market strategies in 12 of the past 15 vintage years, Koenig said. But LPs must be mindful that other strategies have also offered strong performances, and they will need to strategize accordingly, he said.

For instance, though nearly a third (32 percent) of LPs planned to reduce their allocations to large buyouts, according to Hamilton Lane’s last annual private markets survey, the strategy has shown strong returns.

Pooled IRR by vintage years showed that U.S. mega/large buyout funds produced an IRR of 17.8 percent for vintage year 2014, 18.7 percent for 2013, 18.8 percent for 2012 and 16.4 percent for 2011, the study said.

The study also noted LP efforts on value creation, operational assessments, diversity and inclusion and portfolio data and information flow that reflect a strong desire for enhanced capabilities.

Action Item: Read the Hamilton Lane paper here https://bit.ly/2p0AQEc