The Curse of Private Equity: Exploring the Size-Performance Relationship of Private Equity Firms

Abstract: Research on private equity (PE) fund performance is extensive but incoherent. Numerous US studies conclude that fund size increases have a negative impact on net-of-fees returns. This relationship can be seen as a curse of PE, reflecting the difficulty of employing the committed capital effectively when funds grow. However, other studies claim that the relationship is not significant while a few studies even find that size increases have a positive impact on returns. Consequently, there is a need for additional research focusing on what factors affect the size impact on PE performance. Are some PE firms able to evade the curse? We test if a negative size-performance relationship exists in PE. In contrast to previous studies, we capture the interplay between fund characteristics and size by including variables such as regional focus, industry focus and fund type (venture capital or buyout) along with an interaction variable with size for each characteristic. Our results confirm a negative size-performance relationship in PE on an aggregate level, but we find exceptions. In contrast to US funds and venture capital funds that are more sensitive to size increases, European funds, buyout funds and funds specialized in infrastructure are more tolerant of size increases. Further we expect certain PE firms to be more skilled in managing size disadvantages, independent of region, industry focus or fund type. Consequently, we test if such firm specific skill factor can be observed when measuring the impact of net-of-fees returns as fund size increases. We conclude there is a significant skill-factor affecting firms' abilities to manage size increases.