Abstract
This paper studies the relationship between portfolio diversification and fund performance, based on an unexplored, hand-collected dataset of buyout funds. The dataset comprises detailed information at the level of portfolio companies, which allows measuring the concentration of the fund portfolios towards individual companies, industrial, and geographical focus. Our results suggest that diversification within, but not across industries, associates with higher buyout fund performance. We do not find a significant relationship between geographical diversification and performance. These results partly contradict results documented in prior literature.
Highlights
This paper provides an empirical analysis of the relationship between portfolio diversification and fund performance of buyout funds
The application of the Hirschman indices (HHI) and the control for systematic risk have important implications on the empirical results: our results based on the naive diversification measure are in line with the results reported by Humphery-Jenner (2012, 2013)
Consistent with the results reported by Humphery-Jenner (2012, 2013), these findings indicate that funds with a more diversified portfolio tend to generate a higher internal rate of return (IRR)
Summary
This paper provides an empirical analysis of the relationship between portfolio diversification and fund performance of buyout funds. Turning to studies that include buyout funds, results reported by Humphery-Jenner (2012, 2013) suggest a positive relationship between industrial or geographical diversification, and private equity returns. His sample includes both venture capital and buyout funds, the performance results are not disaggregated by investment style. The application of the HHI and the control for systematic risk have important implications on the empirical results: our results based on the naive diversification measure are in line (yet not statistically significant) with the results reported by Humphery-Jenner (2012, 2013) Consistent with his findings, our results suggest that diversification across companies, industries or geographical areas is positively related to a fund’s internal rate of return (IRR). Our dataset does not include the names of the funds, or a comprehensive set of fund characteristics, which limits our ability to control for potentially relevant variables (e.g., the experience of the GPs’ management teams) in our empirical analysis
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