According to new research from Schroders, private equity funds that invest into small and mid-cap companies perform better than their large cap peers, creating superior returns.

“Any private equity fund that is well managed, with the right portfolio of investments, can generate attractive return. But large size is not a guarantee of performance, and our research has found just the opposite,” said Claire Smith, head of private assets sales at Schroders.

“Our research shows that, all things being equal, private equity funds that buy small and mid-cap companies statistically perform better than their large cap peers thanks to a greater number of opportunities, lower entry multiples and a longer runway for growth,” said Ms Smith.

That is backed by data. On average, small and mid-sized private equity managers – of which Schroders Capital is one – have outperformed their large private equity peers, both on a net total value paid in (TVPI) basis for vintages after 2005 and on a net internal rate of return (IRR) basis for vintages after 2009, as the charts below show.

“This trend can also be seen across different geographic regions and investment strategies. Between 2000 and 2017 across Asia, North America and Europe, small and mid-sized funds delivered higher net returns than large private equity funds, while small and mid-venture, growth and buyout funds also outperformed their large counterparts,” Ms Smith said.

“Big superannuation funds have huge amounts of capital to deploy and arguably too few resources to filter opportunities outside the large and mega-cap buyout space. So that’s where they go, and it’s costing them in terms of returns,” she said.

According to data from global research firm Preqin, fundraising among large-cap funds between 2010 and 2022 grew by 10.7x while deal flow grew at 3.6x. This imbalance between capital supply and demand pushed up entry multiples, thereby compressing overall growth multiples for investors.

Small and mid-sized funds, by contrast, saw deal flow growth of 4.2x against fundraising growth of just 2.9x. The lower supply of capital, coupled with relatively higher demand, encouraged lower entry multiples, paving the way for superior returns.

“These lower entry prices make a big difference. In short, we buy companies at low entry multiples while they’re small or mid-sized, and sell them up market when they’re large caps, ensuring a relatively better return for investors,” Ms Smith said.

Historically private equity has only been available to institutions and high net worth investors. But now, with more private equity funds being offered to retail investors and minimum investments amounts falling, private equity is attracting interest from a greater range of investors.

The Schroder Specialist Private Equity Fund has returned 17.4 per cent per annum after fees since inception in 31 March 2020, and 13.7 per cent return over the year to 31 December 2023, after fees.  The Fund aims to generate an absolute return of 10 to 12 per cent, net of fees, over periods of five years and longer, providing attractive returns for investors with a long-term investment horizon.

“While the underlying investments are illiquid private equity assets, the fund provides investors with the opportunity to access their capital on a quarterly basis, noting a cap of 5 per cent of the net asset value applies at the level of the underlying global fund, opening up the opportunity to a greater range of investors,” said Ms Smith.  

The Fund has a “Recommended” rating from both Zenith and Lonsec.

It is available on most platforms including: BT Panorama, BT Wrap, AMP MyNorth, Macquarie Wrap, uXchange, Xplore Wealth, HUB24, Power Wrap, Mason Stevens, Insignia Expand, CFS FirstWrap / Edge and Netwealth.