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Investors in private equity funds are betting on smaller firms in the hope they will be better able to exit holdings during a prolonged dealmaking downturn than their larger rivals.
Pension funds and endowments are on track to reduce their overall commitments to the sector for the second consecutive year, but so-called middle market firms won a bigger slice than their larger peers.
Funds targeting between $1bn and $5bn captured $142bn in the first nine months of this year, or 44 per cent of global commitments. That was their highest share in data dating back almost two decades and 8 percentage points more than last year.
Larger funds, meanwhile, captured just $104bn to reduce their share of global fundraising from 43 to 33 per cent, according to data from PitchBook.
Market dynamics started to shift as the buyout sector battled through its third difficult year since higher interest rates left firms struggling to sell portfolio companies, with investors and advisers noting that larger funds were among the hardest hit.
The dealmaking drought has left private equity managers returning less cash to the investors in their funds, leaving those backers with less cash to recycle into new funds and being more selective about future partners.
“We think the median returns in the mid-cap and smaller part of the market will be better than in the larger,” said Tony Tutrone of Neuberger Berman, the New York firm that manages assets worth more than $500bn and is a major investor in private equity funds.
Tutrone said he would still work with larger managers because they bought high-quality companies and, people in the industry say the handful of very largest funds — such as those bigger than $10bn — have recently proven particularly popular because of the perceived reliability of their managers.
But Tutrone added that Neuberger had increased its commitments to middle market firms for four years in a row and planned to increase them again in 2026.
Funds focused on smaller acquisitions had larger pools of targets as well as more options to exit them, he said, given they could sell smaller companies to larger private equity funds as well as to corporates or on public markets.
Ali Floyd, co-head of European private equity fundraising at advisory firm Campbell Lutyens, said he had seen “sharply increased interest in the mid-market from institutional investors”.
Investors and advisers said there were also more opportunities to improve smaller companies — particularly important in a higher-rate environment where leverage could not be relied upon to boost returns.
“You’re much more likely to be able to transform underloved companies at a smaller fund size, as you’re looking for a business not yet reaching its full potential,” said Gabrielle Joseph, head of client development at adviser Rede Partners.
Many big funds had refrained from undertaking fundraising rounds this year, she added, because of their difficulty in selling companies and returning cash to their backers.
The global private equity sector raised about $320bn in the first nine months of this year, putting it on track to raise roughly $425bn by the end of December. That would represent a 28 per cent drop on last year.