In private equity, bigger isn’t necessarily better.
Private equity strategies that have less than $350 million in assets, and that focus on investing in esoteric industries or businesses, continue to meaningfully outperform their larger peers, according to data collected by Mantra Investment Partners, a firm that tracks and invests in smaller private equity funds.
Mantra analyzed the historical internal rate of return (IRR) and multiple on invested capital (MOIC) across more than 5,000 deals, 500 funds, and 242 private equity firms to create the Mantra Niche PE Index. The firm began to publish the index performance earlier this year.
Niche private equity funds delivered an average IRR of 38 percent and a MOIC of 2.2x net of fees over the past ten years. During the same period, broadly diversified funds of all sizes in North America averaged an 18 percent IRR and 1.7x MOIC. (Mantra compared the niche PE index to an aggregate composite created by PitchBook that included, among other things, lower-middle-market buyout, growth equity, venture capital, and other investments across industries.)
Even mainstream private equity’s top quartile performers failed to outperform the Niche PE average, with a 27 percent IRR and 2x MOIC over ten years.
“Niche PE managers typically acquire, on a proprietary basis, assets that are either too complex or too esoteric to form the central focus of mainstream PE managers,” said Antoine Drean, a founding partner at Mantra. “Because there’s materially less capital chasing specialized niche opportunities, returns tend to be a lot higher than those for the mainstream.”
The niche private equity firms included in Mantra’s index are focused on a variety of sectors, including information technology, industrials, healthcare, financial, food and agriculture, and other industries, but only 32 percent of them are focused on more than one area. Larger private-equity firms are active in many of those industries, but the niche managers are narrowly focused within them.
For example, a buyout fund might be centered specifically on the intersection of aerospace and defense, cybersecurity and government services. Another firm could invest in agriculture companies, but be focused on new fast-growing areas within that sector, such as alternative proteins and crop protection using pest management pheromones. A private equity firm focused on financials could be exclusively interested in litigation finance or royalties.
Using MOIC, niche strategy outperformance was more modest compared to others in PE. That’s because they have shorter holding periods, which are typical of their specialized investments. “Faster growth typically means niche PE companies get sold faster and investors can reinvest more rapidly, making up for any relative reduction in outperformance based on multiples of invested capital,” Drean said.