Unlike the early days of private equity, when generalist private equity firms predominately relied on financial engineering to generate returns, today’s competitive markets require a much deeper understanding of a sector’s nuances to drive earnings.
As the private equity markets have become more competitive, to differentiate and enhance returns, private equity firms are increasingly required to focus on helping companies drive revenue, margin improvements, and operational efficiency. Sector specialist private equity firms are often best situated to do this, applying deep expertise and a robust network to improve companies and drive more tangible improvements in operational performance. Additionally, as capital has become less scarce, business owners began to seek out private equity firms with deep networks, knowledge, and proficiency of their respective industries and companies. The firms that started winning more deals were the ones who were able to demonstrate an understanding of the unique opportunities and challenges each sector faced through their years of operating and investing within that space. These advantages have resulted in sector specialists outperforming generalists.
Looking at 15 vintage years of private equity performance from 2006-2020, sector specialists have outperformed their generalist counterparts, delivering a median TVPI of 1.81x relative to generalists’ median TVPI of 1.69x. Of note, this higher performance was seen across almost all metrics, and with top quartile and bottom quartile sector specialist managers outperforming generalists, outlined in the graphs below:
These sector specialists don’t just outperform their generalist peers on an absolute basis but do so in almost every vintage year as well. Looking at outperformance relative to the public markets, using pooled GGS Direct Alpha1 against the S&P 500 within 2006-2020 fund vintages, sector specialists outperform generalists in all but two vintage years (2010 and 2011). Observing aggregated manager performance in the graph below, sector specialists outperform generalists on average by 1.0 percent relative to the public markets, beating the public markets by 2.3 percent annualized. Additionally, we’ve observed certain sectors, notably Healthcare and Information Technology (“IT”), have significantly outperformed given the tailwinds both sectors have experienced in the past two decades. Healthcare specialists have benefitted from an aging population which increases demand for healthcare products, rising healthcare costs which promotes medical supply innovation, and the proliferation of data which drives IT-integrative solutions across most all types of healthcare systems. IT specialists have thrived in the digital age, realizing returns from the technological modernization of companies, the increasing adoption of software, and the need to privatize and securitize data across many industries.
In summary, sector specialists have a distinct advantage over generalist managers, utilizing their deep industry expertise and networks to source and win more deals as well as help companies improve operating performance. With their unique insights, gained from careers dedicated to a specific sector, sector specialists have been able to outperform generalists on both an absolute basis and relative to the public markets, firmly establishing their value and ensuring they will remain a driving force in the investment landscape for the foreseeable future. As such, investors should consider the incremental alpha that sector specialists can deliver when incorporated into a portfolio.
- The Annualized Excess Return is calculated using the pooled Gredil, Griffiths and Strucke Direct Alpha method compared against the S&P500. The calculation was performed by Burgiss.
