Gupta’s research using SEC filings points to diseconomies of scope, whereby if a GP invests across too many sectors, there is a detrimental impact on returns. However, this is offset by a reduction in risk, leading to better risk-reward ratios. What does this mean for investors in the context of an increasingly specialised private markets universe?
Reji Vettasseri: “The logic is clear. If you can become a real expert in a certain field, hiring specialist knowledge and building strong networks, you will have better access to deal flow, better-quality information, and a greater ability to add value. The only real danger comes if you focus too narrowly, or if you focus on a sector that is overly cyclical. For example, a lot of financial services specialists struggled in a low interest rate environment.”
Luke Riela: “Some of the best managers have focused on developing sector expertise over the years, building up strong resources around those industries, although we also see some more generalist GPs generating strong performance. With regards to the importance of diversification, it is possible to aggregate different sector specialists, achieving diversification on a portfolio basis, even if you are not getting it through individual funds.”
Josh Lerner: “I agree. It is important to differentiate between the benefits of diversification for the GP and for the LP. LPs hold interests in dozens if not hundreds of different funds, so it may be optimal for them to have individual GPs specialise, especially where they have a specific competitive advantage.”
