The Best-Performing Private Equity Funds Share These Two Attributes

With a 40 percent internal rate of return, these funds far outperform others.

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A group of private equity funds delivering eyebrow-raising performance aren’t exclusively focused on one industry or located in a specific region. They share a certain size and focus — two critical attributes helping them beat competitors.

In 2023, Mantra Investment Partners, a firm that tracks and invests in small private equity funds, 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. The analysis quantified what the firm had observed for many years: private equity strategies that have less than $350 million in assets, and that focus on investing in esoteric industries or businesses, meaningfully outperformed bigger funds.

The latest data from 2011 to 2021 shows funds with a narrow investment focus or niche delivered an average IRR of 38 percent and a MOIC of 2.3x net of fees. During the same period, broadly diversified funds of all sizes in North America averaged an 18 percent IRR and 1.7x MOIC. (Mantra compared its niche PE index to PitchBook data for a group of funds that included lower-middle-market buyout, growth equity, venture capital, and other investments across industries.)

Even mainstream PE’s top quartile performers — with 25 percent IRR and a MOIC of 1.9x — failed to outperform the mean of Mantra’s Niche Private Equity Index.

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But do niche private equity funds still perform so well regardless of how big they are? Mantra set out to answer that in its latest research and the answer was clear: they don’t. From 2017 to 2021, niche funds with less than $500 million in capital had an IRR of 40 percent while funds with between $500 million and $2 billion had an IRR of 32 percent, according to Mantra’s research and Preqin data. Regardless of their size, all funds with a niche still surpassed similar peers without one.

“Successful GPs tend to raise significantly larger funds over time. Rising fund sizes risk GPs losing focus from their original, successful strategies. This has the potential to undermine value creation and produce lower returns,” the report says.

The big, marquee generalist fund managers have had an easier time raising new capital than smaller private equity firms and investors could be missing out on better performance, according to Mantra. Some institutional investors have so much money to invest that they need large funds to accommodate them, but many can invest in smaller funds.

However, the firm also cautioned that selecting smaller PE managers and funds requires major due diligence. “Returns dispersion is wider among smaller PE funds. Therefore, it is paramount to select managers that can fetch the true alpha in private equity,” the report said.

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