Some large buyout fund groups with lofty reputations consistently post mediocre results. Their popularity is puzzling.

A potential investor in a buyout fund group can be like a major league baseball team looking to sign an All-Star batter, two Johns Hopkins Carey Business School researchers suggest in a recent paper. Imagine the ball club decides to bring aboard a well-known name with a long track record of solid production, and at season’s end he has posted a batting average of .279. Respectable, sure, but disappointingly shy of the bang that the team expected for its bucks. In a similar way, say Senior Lecturer Jeffrey Hooke and Associate Professor Ken Yook, investors often turn to established “winners” of the buyout fund industry. These are large firms with famous names such as Bain and Goldman Sachs, but whose buyout fund results are only slightly above average. And yet investors continue to favor these large firms over smaller ones that perform nearly as well and cost about the same as the heavy hitters.

Buyout funds – leveraged investments in private companies that are not listed on a stock exchange – constitute a significant chunk of the private equity market that has boomed in recent decades. The funds were responsible for raising $152 billion of new capital in 2015, according to Preqin, a global company that compiles data on alternative assets. As Hooke and Yook note, buyout funds represent most of the money committed to private equity, and the 18 biggest funds account for up to 25 percent of buyout equity commitments.

And the results that the big firms post? Only so-so, particularly when compared with the small firms’ numbers. (The researchers define a large firm as one with at least five individual buyout funds and capital under management exceeding $3 billion.)

For funds with vintage years 1994-2007, the authors report, about 77 percent of the funds sponsored by the large groups surpassed the Standard & Poor’s 500 average. The small group funds weren’t far behind; 71 percent of them beat the S&P. (More recent vintage years, 2006-2016, show a greatly reversed performance, with 75 percent of all buyout funds consistently falling short of the S&P average. The term “vintage year” refers to the year in which a fund received its initial investment of capital.)

In addition, when comparing average quartile fund rankings from vintage years 1993-2013, Hooke and Yook observe that the larger groups recorded a decent but less-than-stellar mean of 2.16. (A ranking of 2.50 is the average; any lower number is better than the average.) Four of the large groups – Goldman, KKR, Kohlberg, and Thomas H. Lee – posted average quartile results at 2.50 or slightly worse.

A broad sample of smaller groups from that period hardly disgraced themselves with their 2.47 mean.

While better than average, the large groups’ mean of 2.16 is, the authors write, “quite distant from a 1.0 first quartile ranking, where, in recent years, the bulk of the alpha [a return that tops the S&P] occurs. These results throw the … continued dedication to these large family fund groups into question.”

“The main point of our paper is to refute the conventional Wall Street wisdom that the big-name funds are better than the smaller ones. It’s not true. It looks like the big ones are living off their reputations,” says Hooke, who, like Yook, has expertise in corporate finance, private equity, and investment banking.

“The main point of our paper is to refute the conventional Wall Street wisdom that the big-name funds are better than the smaller ones. It’s not true. It looks like the big ones are living off their reputations.”

Yook adds: “When you look at data from about 2005 to 2015, the large fund families’ mean quartile ranking was even worse, at 2.50, exactly equal to an average or random result. This suggests that the large funds provided no premium during those 10 years, compared with what their smaller competitors were doing. It also suggests that buyout fund managers, like their colleagues in other asset-management industries, revert to the mean over time.”

The authors offer several possible explanations for the continuing popularity of the large groups, despite their underwhelming results. These include investor conservatism (feeling more comfortable with a “name brand” fund), better marketing (thanks to the big firms’ generous budgets for paid media, sponsorships of investment conferences, and other promotional strategies), and size considerations (especially for institutional investors that believe the big rms are more skilled at handling sizable pools of money).

In an interview, Hooke questions not only the choice of the large buyout fund groups but also the entire market: “I think a rational person would avoid the buyout fund investments altogether. Why? Because buyouts are essentially leveraged equity funds, and still the statistics show that only the top quarter of buyout funds beat the S&P 500 from ’06 to ’16. So three-quarters of them came in lower than that broad benchmark.”

The paper, “The Relative Performances of Large Buyout Fund Groups,” appeared in the winter 2016 issue of The Journal of Private Equity.