November 2014

Sector-Focused Private Equity Funds Often Outperform Generalists And Should Be Considered When Building Portfolios, Says Cambridge Associates Report

Managers Who Have “Declared a Major” in Specific Sectors Can Leverage Industry Expertise to Make More Informed Investments; LPs Should Consider Sector Funds When Constructing Private Equity Portfolios

Boston, MA (November 12, 2014) – In an increasingly competitive private equity environment, sector-focused managers’ intimate knowledge of specific industries often enable them to outperform generalists invested in the same sectors. However, incorporating these “sector specialists” into private equity portfolios has yet to gain widespread acceptance as a strategy, despite the significant number of sector specialists used in venture capital, according to the newly-released report from global institutional investment advisor Cambridge Associates, Declaring a Major: Sector-Focused Private Investment Funds.

The report finds stark differences between sector-focused and generalist private equity funds. Sector specialists, defined in the report as historically investing more than 70% of capital in one of four sectors – consumer, financial services, health care and technology –returned an aggregate 2.2 times multiple on invested capital (MOIC) and a 23.2% gross internal rate of return (IRR) between 2001 and 2010. Those returns handily outweigh the 1.9 times MOIC and 17.5% gross IRR returned by generalists funds invested in the same sectors.

“This outperformance comes from intimate knowledge of an industry – in an increasingly competitive private equity environment, a manager’s ability to demonstrate deep expertise in a focused field is a key differentiator,” says Andrea Auerbach, Managing Director and Global Head of Private Investment Research at Cambridge Associates and co-author of Declaring a Major. “Investors building private equity portfolios should keep them in mind as one arrow in their quiver of investment return generation.”

Making the Grade: Sector Specialists Have Consistently Outperformed Generalists

Between 2001 and 2010, sector-focused investments in the consumer, financial services, health care and technology sectors outperformed generalists on a number of scales:

  • Consumer-focused, financial services-focused, health care-focused and technology-focused funds earned 2.3, 2.1, 2.2 and 2.3 times MOIC, respectively. The sector specialists generated a 21.3%, 23.3%, 25.1% and 23.5% IRR, respectively. Meanwhile, generalists’ investments in these four sectors earned 1.9, 1.7, 2.0 and 2.0 times MOIC, respectively, while generating a 17.9%, 13.9%, 17.3% and 19.8% IRR, respectively.
  • Sector-focused funds also outperformed generalists across the spectrum of fund sizes. They earned higher MOICs in each of the following fund size categories: funds of less than $250 million, $250-$500 million, $500-$750 million, $750 million to $1 billion, and greater than $1 billion.
  • Sector-focused investments have also resulted in fewer losses than generalist investments in those sectors. Examining the returns of sector-focused investments against generalist investments in the same space revealed capital invested by specialists more often led to higher returns, and less often led to lower returns. “Not only do specialists identify better investment opportunities, they also avoid marginal ones,” adds Auerbach.

Sector-Focused Funds Are Often At the Head of the Class and Use Industry Expertise to Avoid Pitfalls

When it comes to investing in sector specialists, a key concern is that they would be compelled to deploy capital during unattractive market conditions, or into unattractive investment opportunities in their space. However, sector specialists do not appear to be indiscriminately “buying the market.”

On the contrary, since 2004, the report observed generalists deployed more capital into higher market valuation environments within each sector, based on public market valuations as a proxy, while specialists demonstrated more discipline through different valuation cycles.

“The focused and dedicated resources that sector specialists can devote within a sector allow them to be closer to industry participants, trends and themes, and sometimes they can see attractive investment opportunities that generalist firms may overlook,” says Josh Zweig, Investment Director of U.S. Private Equity Research at Cambridge Associates and co-author. “Of course, not every student aces the quiz, so careful manager selection remains critical as investors explore sector specialists.”

Sector Specialization and Portfolio Diversification Not Mutually Exclusive

The report acknowledges investors will need to determine at what level – the overall portfolio level, the asset class level, or the fund level – industry diversification will be taken into consideration.

“Although the narrower focus of sector specialists should not be overlooked in terms of overall portfolio construction, institutional investors should not assume that allocating capital to sector-specific managers removes the possibility of maintaining a healthy level of diversification,” says Auerbach. “Since we expect the private equity industry to only become increasingly more complex and competitive, sector-focused private equity funds are worth considering when constructing a long-term investment portfolio.”

For a copy of the report, “Declaring a Major: Sector-Focused Private Investment Funds,” please visit To arrange for a conversation with the authors, please contact Frank Lentini, Sommerfield Communications at (212) 255-8386 /