Large Cap vs. Middle Market Investing
Heading to PE after I finish my two years in IB, and have a few things I'm curious about what people think:
- The associate experience variance between LMM/MM/UMM/MF has been covered ad nauseum, but I'm curious what people think of the return profile of large cap vs. mid-cap investing? As in, are LPs expecting the same type of returns from these firms nowadays, or is a large cap strategy seen as inherently different from mid-cap?
- I've been told that MM is generally more operationally / financial engineering-focused in terms of driving value (cost-cutting, levering up a business that hasn't historically tapped the debt capital markets for funding growth), whereas large cap is more strategy-focused (the management teams should already know what they're doing so there's not as much the PE firm necessarily brings to the table operationally, but rather the PE firm is thematically betting on a certain area and picking the right company as a proxy of that theses). Is this generally true?
- How do the economics differ as AUM changes? It seems like the large cap funds don't necessarily have more associates / principals as the more reputable MM firms. At first glance that implies there are just more carry dollars available per professional at a firm with larger fund sizes (assuming similar MOIC). How do MM firms compensate for that? Or is the fact that the spots at large cap firms are just that much harder to get / keep?
LP return expectations for MFs vs MM are different. At the larger fund size net returns of 15-20% (usually closer to 15) are expected but the variability of returns is lower and ability to deploy capital is higher.
For smaller fund sizes, there are higher return expectations as there is a greater argument for "alpha" vs listed markets (as you pointed out on the strategies mid market PE funds pursue).
My understanding is that carry allocations at MFs is lower than say MM when measured in bps. Larger funds tend to have more senior investment professionals or have outside owners (listed, GP stakes funds) and each bps is worth more if the fund does get into carry.
Spent time at both a MF and MM for context:
- All else equal, return expectations are going be higher for mid-cap investing given the lower check sizes that LPs will be writing. LPs are often more concerned with velocity of capital vs. chasing absolute returns and are okay taking a 20% target return for a MF check vs. 25% for a MM check. Know certain LP seats actually get comped based on $ deployment which can factor into the equation.
- Found the opposite to be true regarding financial engineering and strategy. Leverage multiples are going to be lower for MM transactions and businesses are typically less mature, with more room for strategic input from a PE firm. A lot of the LMM/MM diligence process is focused on uncovering obscured value, which requires much more strategic thinking. You're still making thematic bets at the MF level, but these are well-known, sophisticated enterprises where all of the competing firms are underwriting the same thematic bet. Much of your ability to win (by paying the highest price) is your tolerance for underwriting the most aggressive growth case + financing.
- From what I've seen, headcount does not necessarily scale along with AUM, and carry dollars per person are more significant the further upmarket you go. Have seen widely different economics across the MM landscape, however and found it's mainly strategy/firm dependent. You have more aggressive shops (Riverside, Sentinel, Arsenal, ABRY, etc.) that have large funds / AUM but play in smaller deal sizes vs. sleepier funds that probably have slower deployment paces / worse economics. In general, the expectation is that you will work less down market as a trade-off. There are exceptions on both ends of the spectrum however.
Appreciate the response! Interesting view on large cap investing and how firms are competing on risk tolerance and how much they can pay up for a well-known asset. I'm curious given your background, what have you found more appealing long-term / what were the pros and cons of the different investing styles for you personally?
Any insight on ABRY culture / hours? It seems like they have a ton of porticos with relatively few junior IP's. Safe to assume it's a grind shop as a result?
Usually safe to assume
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