Middle market private equity funds outperformance/underperformance vs. large cap funds
Source: Pitchbook as of September 30, 2023, latest data available. Based on one-year rolling return by quarter. Middle market funds range from $100 million to $5 billion in size. Large/mega cap funds exceed $5 billion.
- With the Federal Reserve poised to commence a rate-cutting cycle at its September meeting, this week’s chart reviews the relative performance of middle market private equity (PE) funds versus large/mega cap funds across different rate environments.
- Large and mega cap PE funds have historically relied more heavily on borrowings and multiple expansion to drive returns compared to middle market PE funds. The zero-interest rate environment that endured throughout the COVID-era provided a tailwind to their performance as financing costs plummeted and valuation multiples expanded.
- However, middle market PE funds have outperformed since Q2 2022 as the Fed embarked on one of its most aggressive rate hike cycles in history, driving financing costs higher and somewhat cooling valuations slightly.1
- In addition to less reliance on borrowings to drive returns, middle market PE transactions typically have lower purchase price multiples and derive a higher percentage of value creation through organic growth such as improving earnings, growing margins and expanding product lines for customers. For all these reasons, the middle market has outperformed large/mega cap peers by over 500bps over time.2
- While declining rates may serve as a tailwind to PE performance as an asset class, we believe the diverse makeup of the middle market, and greater reliance on fundamental performance to drive returns versus large cap funds, offers a potential diversified source of growth for client portfolios.
