The rise of billion-dollar private equity buyout funds reflects the growing demand from large investors willing to write big checks. Interest rates remain historically low and, with additional rate cuts almost certain to come, investors continue to expect high returns. The larger the fund, so the thinking goes, the larger the return. This may not be the case.
High-return expectations are the result of a favorable alternative investments environment. According to data from Bloomberg and RSM US LLP, in 2018 there were 25 billion-dollar fund launches alone; through the first six months of 2019, there have been 18 buyout launches, more than any year from 2014 to 2017. The average fund size increased 9% during this period, up to $3.7 billion in 2019 from $3.4 billion in 2014.
Large funds don’t always drive the same performance as their smaller fund counterparts. Higher fees, of course, put more money in managers’ pockets, but that doesn’t guarantee that investors share in the upside. As investors pay more in fees, their expectations for larger returns increases. But, when it comes to fund size, bigger isn’t always better.
According to Pitchbook, U.S. buyout funds with $500 million to $1 billion in assets under management have outperformed billion-dollar funds considerably, reaching a 28.7% return in 2018, compared to only a 9% return for billion-dollar funds. The market for large deals is not as vast, so billion-dollar funds compete with other super funds for the same deals and often modify targeted returns. The middle market does not always have the diverse offering that larger funds do, allowing midsize funds to dig deeper into industry sub-sectors to drive earnings. The larger the company, the more difficult it may be to drive corporate excellence and earnings optimization.
