Manager selection is a critical component of success in any asset class, but particularly in private equity, where manager return dispersion is meaningfully wider than in public markets. Over time, the factors influencing private equity manager selection have become more complex. Investors should account for these changes but remain focused on key factors with a proven history of driving positive outcomes.
Importance of Manager Selection in Private Equity
The historical return spread between top and bottom quartile private equity funds has been around 15%, versus less than 3% for global equities, and less than 1% for public fixed income. This allows for greater value-add in private markets, but it also highlights the importance of implementing a thoughtful approach in order to achieve desired results.
Manager Selection Has Become More Complex
There are a number of factors that have increased the complexity of manager selection within private equity.
- Return persistence has declined, making it harder to predict future outperformance based on prior funds
- Managers are raising capital more frequently, so recent fund performance is less reliable for decision making
- Fund size increases have grown in magnitude, which can lead to strategy drift and lower future performance
- There are significantly more managers and strategies to consider than in the past, and many of these have not been directly tested by a prolonged market downturn
Faced with these challenges, it is important for investors to stay grounded in fundamental factors that have a proven history of creating success. This discipline can reduce complexity and lead to better decision making.
Focus on Fundamentals to Create Favorable Outcomes
What are some of the key factors that investors can focus on to remain disciplined in their manager selection?
- Focus on teams that have invested together in both healthy and challenging market environments
- Remain nimble but avoid trying to time the market
- Favor strategies with long-term, consistent risk-return profiles
- Evaluate less efficient markets like small buyout, but appreciate that inefficiency does not always result in higher returns
- Consider co-investments alongside core existing managers, which can benefit returns and future fund selection
Increased competition and a prolonged bull market have made it more difficult to select high quality private equity managers. In order to remain well-positioned, investors should incorporate changing market dynamics into their decision making while staying true to their core process and beliefs. Doing so can help investors maintain consistent execution and increase the probability of achieving a suitable long-term risk-return profile.
The views expressed herein are those of Asset Consulting Group (ACG). They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm.
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