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Are GP Stakes Still a Sure Bet?

Stakes in small and mid-market firms offer higher returns — but come with higher risk, according to PitchBook.

As more money pours into funds that buy stakes in private capital firms, purchasers of GP stakes are increasingly having to look beyond the big-name firms. This could lead to higher returns — but it’s also much riskier, according to PitchBook.

In a new analyst note, the data firm broke down the risk and returns for buying stakes in GPs ranging from small and emerging managers to the top-end firms — those that have raised at least $8 billion over the past decade.

There’s an obvious case for buying stakes in the largest, most established managers: There’s “virtually no risk” that they will fail to raise additional funds, according to PitchBook. The data firm’s analysts determined that only 3 percent of firms in this category abruptly fail, compared with nearly 25 percent of small GPs — defined as those that have raised between $500 million and $1.5 billion over the past ten years.

Among middle-market private capital firms, the PitchBook analysts found that 11.6 percent failed to raise further funds.

With the higher risks, however, come the possibility of higher returns. Under PitchBook’s base-case scenario, GP stakes funds targeting top-end firms were expected to deliver gross internal rates of return of around 21 percent. Funds investing in small managers, by comparison, were projected to earn gross IRRs of 32.2 percent.

Middle-market GP stakes funds fell roughly in the middle, with a 26 percent expected gross IRR.

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“In GP stakes investing, both risks and returns are high,” wrote PitchBook analysts Wylie Fernyhough and Zane Carmean. “Many LPs choose to mitigate some of those risks by investing with top-end GPs but may miss out on the potential returns generated by some middle-market or small manager-focused GP staking firms.”

As more money pours into GP stake funds, however, the PitchBook analysts expect that more deals will target small and mid-market managers. For one thing, the pool of big private capital firms that haven’t already sold stakes is shrinking: In a previous analyst note, PitchBook reported that nearly 42 percent of top-end managers had already sold a stake.

By contrast, only 8.5 percent of mid-market GPs and 2.9 percent of small GPs had sold stakes as of May 31.

“As this transaction type becomes more normalized as a means for GPs to raise permanent capital and/or hasten their growth plans, it should allow for more deals to close and capital to be deployed, especially with middle-market and small managers,” the PitchBook analysts concluded.

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