Small is beautiful for buyout returns

Mega buyout funds have been a bad bet over the past year, generating the worst returns when compared with small and mid-market funds, according to a study issued by research firm Preqin last week.

Funds larger than $4.5 billion made a negative return of 31.4% for the calendar year ended June 2009, the report said. For the same period, mid-market fund returns were down 16.7% and small buyout funds had negative returns of 12.9 percent.

London-based Preqin reported that large buyout firms struggled to finance substantial deals after the credit crunch, and investors have been far more hesitant to commit to such funds.

“Not only has financing for new deals been an issue, but financial management for existing investments has also presented a major worry,” Preqin said in the report. Mid-market and smaller buyouts funds are currently providing more appeal, it said.

The study is not too surprising and is in line with past studies showing that the best percentage returns come from smaller funds, which is also true of venture funds.

It’s worth noting that percentages are only one return metric that LPs must consider. The other is cash-on-cash returns.

Mega buyout funds are also providing the worst returns over a three-year period, down 3.1%, while large, medium and small buyouts all posted positive returns, Preqin said.

Separately, Preqin reported that private equity fund-raising slumped to its lowest level in five years in 2009 as investors held back from making new commitments, focusing instead on their existing portfolios.

A total of $246 billion was raised by 482 funds worldwide in 2009, down 61% from 2008 and the lowest level since 2004, according to Preqin.

Also, the average length of time to raise a fund has increased dramatically in the past two years, now standing at more than 18 months. It previously took just a year.

The largest funds that finished fund-raising in 2009 included CVC European Equity Partners V, which raised $10.7 billion; First Reserve Fund XII, which raised $8.8 billion; and Hellman & Friedman VII, which raised $8.8 billion.

The chances of a return to the fund-raising levels seen in 2007 and 2008 are “very slim,” the research firm said. “As a result of the lack of distributions that they have received from existing investments, investors have less capital available to commit to new funds,” it said.

Kohlberg Kravis Roberts & Co. is expected to launch a new fund at some point, but the firm is reserving judgment on when to begin marketing the next fund, a source close to KKR previously told Reuters. KKR has about $5 billion in un-called capital from its 2006 fund. —Megan Davies, Reuters