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Private equity core and satellite allocations

We evaluate private equity satellite strategies alongside an allocation to core buyout funds. Deeper analysis shows that adding satellite funds to a portfolio of core buyout funds can improve risk-adjusted returns and tilting to one satellite or another might accelerate reaching the objectives of the investor.

We analyzed the five main strategies across private equity and compared each on a standalone basis focusing on characteristics such as risk-reward, cash flow profile, value creation and diversification. Our analysis showed that on a portfolio level, adding one strategy to the other could increase the risk-adjusted return of the entire private equity portfolio. We see opportunities for investors to use these strategies as flexible building blocks or modules to build a private equity program that is more customized to objectives.

Overview

Our research focuses on the role of satellite strategies alongside an allocation to core buyout funds and how satellite funds can complement core buyout funds. We first reviewed core and satellite funds on a standalone basis, discussing risk-reward, cash flows characteristics, diversification and value creation for each of these five strategies. We then looked at how adding satellite funds to a portfolio of core buyout funds could improve risk-adjusted returns. Our analysis also showed that allocation tilts to one satellite or another could help investors accelerate reaching their objectives.

Five satellite strategies

  • Core buyout funds invests in large and mega buyout deals and make up largest part of the overall capitalization of private equity.
  • Small and mid-sized (SMID) buyouts make investments in smaller companies but typically structured in a similar way as large and mega buyouts.
  • Late stage venture capital and growth equity (Growth equity) invest in younger, high growth businesses that are disrupting traditional economies and industries with a focus on execution and scale.
  • Special situations are triggered by specific circumstances within the company that require not only investment, but also support.
  • Asia focused are all buyout, growth equity and distressed investments in companies located in or with significant revenue streams from Asia Pacific.

Standalone comparison between core buyout funds to satellite funds

Aggregate or pooled returns can be interpreted as a passive investment in a private equity index, having exposure to all private equity funds. However, a passive exposure across the private equity universe is not feasible for most investors, so manager selection and commitment size are the most important investment decision to achieve incremental returns and manage risk when investing in private equity.

Robust performance across core and satellite funds

Risk-return characteristics

Risk-return characteristics

Source: Burgiss Private iQ as of 30 June 2020. Dataset covers 2,199 funds, representing USD 2,498b. Buyout – Large Mega covers Buyout funds defined by Burgiss to be greater than USD 2.0b in total fund size. Buyout – SMID covers Buyout funds defined by Burgiss to be between USD 25m and USD 2,000m in total fund size. Growth Equity covers Late Stage Venture Capital and Expansion Capital funds greater than USD 25m. Distressed covers Distressed funds defined by Burgiss greater than USD 25m in total fund size. Asia covers Buyout, Late VC/Growth, and Distressed strategies greater than USD 25m. The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results. Index performance returns do not reflect any management fees, transaction costs or expenses. Indices are unmanaged and one cannot invest directly in an index.

Satellite funds in a portfolio of large-mega funds

We’ve highlighted various characteristics of five strategies on a standalone basis. However, most private equity programs consist of a mix of each of these strategies and hence it is important to understand the role of each strategy in the aggregate program, and in particular how these strategies affect the risk-reward of the total program. This can be studied using simulations where randomly constructed programs consisting of a mix of strategies are analyzed.

Randomly constructed portfolios of a mix of strategies

Simulated mean and dispersion of IRR

Simulated performance data of 21 portfolios consisting of large-mega and growth buyouts (ecludes the bottom quartiles)

Source: internal and Burgiss Private iQ as of 30 June 2020 (515 funds). Vintages 2001-2017 are included in this analysis. The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results. Index performance returns do not reflect any management fees, transaction costs or expenses. Indices are unmanaged and one cannot invest directly in an index.

Risk adjust return

Sharpe and Sortino ratios for simulation results

BlackRock analysis of risk adjusted return of private equity strategies.

Sharpe and Sortino ratios for the simulation results shown in the top chart. Source: internal and Burgiss Private iQ as of 30 June 2020 (515 funds). Vintages 2001-2017 are included in this analysis. The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results.  Index performance returns do not reflect any management fees, transaction costs or expenses. Indices are unmanaged and one cannot invest directly in an index.

Key takeaways

01

This paper lays out the characteristics of the five main private equity strategies: core mega-large buyout funds and four satellite strategies being small-mid buyout funds, growth equity, distressed and Asia-focused funds.

02

On a standalone basis, it is shown that these strategies differ not only in their risk-reward characteristics but also in cash flow profiles, value creation levers and diversification properties.

03

From a total portfolio perspective, it is shown that adding satellite strategies to a collection of core buyout funds can improve the risk-adjusted return of the total portfolio beyond what could be achieved by both strategies in isolation hence demonstrating the complementary nature of these satellite strategies.

Private equity core and satellite allocations
In this paper, we provide an evaluation of satellite strategies next to an allocation to core buyout funds. Deeper analysis shows that adding satellite funds to a portfolio of core buyout funds can improve risk-adjusted returns and tilting to one satellite or another might accelerate reaching the objectives of the investor.
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Jeroen Cornel
Director, BlackRock Private Equity Partners
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Kyle McDermott
Analyst, BlackRock Private Equity Partners
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