hard · Private Equity & LBOs
Two buyout funds, X and Y, each return exactly 2.0x net MOIC and 20% net IRR to LPs over identical 5-year average holds. Fund X is a concentrated 8-deal fund; Fund Y is a 40-deal fund. An institutional LP's investment committee prefers Fund Y, citing 'better risk-adjusted returns from diversification.'
Assuming the realized headline numbers are as stated, what is the subtlest reason this preference may be MISGUIDED on a forward-looking basis?
- Realized identical MOIC and IRR mean the funds had identical risk, so the diversification argument is irrelevant to the decision
- Diversification within a single illiquid asset class with correlated exposures may reduce idiosyncratic dispersion but does little against the systematic, vintage-level risk that actually drives realized buyout outcomes, so Y's edge can be largely illusory
- A 40-deal fund mechanically has a higher MOIC than an 8-deal fund, so the equal realized figures already prove X outperformed on a per-deal basis
- Concentration always dominates diversification in private equity because the J-curve is steeper for fewer deals
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