Why the choice of fund manager carries so much weight

If you invest in a listed equity fund, you usually notice little difference between a good fund and an average one. Many funds partly own the same large companies and largely move with the market. Private equity is different. A fund manager buys a limited number of companies, negotiates the price itself, works on improvements for years and chooses the moment of sale. As a result, results vary widely between fund managers.

How big is the difference?

A common way of measuring this is to rank all fund managers in a category in order, from best to worst performing, and divide that ranking into 4 equal parts. The top quartile is the group with the highest returns, the bottom quartile the group with the lowest. The difference between the threshold of the top quartile and the threshold of the bottom quartile shows how far apart the results are.

J.P. Morgan Asset Management set out that difference over the past 10 years. For global equity funds, the top quartile achieved more than 12.7% per year and the bottom quartile less than 9.1%: a difference of 3.6 percentage points. For private equity, those thresholds were 20.4% and 1.1%: a difference of 19.3 percentage points, more than 5 times as large.

And these are only the thresholds of the 2 groups. The best and worst funds themselves are further apart.

The same picture in every vintage year

This is not a chance outcome of a single period. When buyout funds are compared by vintage year, the top and bottom quartiles are also consistently far apart. For funds that started investing between 2002 and 2022, the difference in return per year was never smaller than 9.0 percentage points (vintage year 2018) and rose to as much as 21.1 percentage points (vintage year 2003).

A difference of 10 percentage points per year may sound abstract. As a highly simplified illustration: if €100,000 grows by 10% per year for 5 years, it is worth over €161,000. At 20% per year, it is worth over €248,800.

For the youngest funds, the figures are still provisional. As described in our article on the J-curve, value creation takes time and the final result is only fixed once all the companies have been sold.

Good past results are no guarantee

It is natural to choose a fund manager that did well last time. That is a logical start, but it is not enough. A fund manager raises new money while the previous fund is still running. At that point, the return of that fund is largely an interim result, and interim results change. Research by Harris, Jenkinson, Kaplan and Stucke on US buyout funds shows that of the funds that were in the top quartile during fundraising, 54% also ended up there.

A good figure is therefore a start, not an answer. When you assess a fund manager, you also look at what lies behind it: how the return was achieved, whether the team is still the same, whether the approach is repeatable and whether the team invests its own money alongside investors. That requires thorough research and access to information that is not public.

What does this mean for investors?

Given these large differences between fund managers, 2 things help. The first is selection. A careful analysis of team, approach and results increases the chance of a good choice, but is never a guarantee.

The second is diversification across several fund managers. If you invest in one fund, you are entirely dependent on one team. If that team disappoints, it affects your whole investment. If you spread your commitment across several funds, you limit the impact of one disappointment. That is the idea behind a fund of funds: a fund that itself invests in a number of carefully selected private equity funds.

Diversification also comes at a price. A fund of funds charges its own fee on top of the costs of the underlying funds. And diversification dampens the impact of one positive outlier in the same way as that of one disappointment. The risk of a disappointing result decreases, but does not disappear.

The choice makes the difference

In private equity, the difference between a good and a less good fund manager is large, much larger than on the stock market. The question of who you invest with in private equity is therefore at least as important as the question of whether you do so at all.