ON THE PANEL:

Tom McComb JP Morgan Asset Management Tom McComb is a managing director at JP Morgan Asset Management where he leads the management of the private equity portfolio. Prior to JP Morgan, McComb worked at AT&T Investment Management Corporation where he managed a broad range of private markets assets.

Mounir Guen MVision Mounir Guen is the founder and chief executive of fund adviser MVision. Guen was with Merrill Lynch before founding MVision in 2001 and he has advised on more than 300 fundraises during his career.

Sector specialism has become a decisive differentiator for managers when executing deals and LPs appear to be pivoting towards sector specialists in greater numbers.

But why is this? Do sector specialists deliver superior returns? How do LPs allocate capital by sector, on what criteria are sector specialists assessed, and what happens when there are long-term shifts in sector performance?

In a recent Real Deals podcast, MVision’s Mounir Guen and JP Morgan Asset Management’s Tom McComb shared their thoughts on sector specialist managers and their position in the market. Here are some of the highlights:

Assessing sector specialist capability

McComb said his team assessed a manager’s sector specialism by conducting due diligence as it would on any manager.

“We are trying to understand the manager’s experience and network and how they will be able to use those attributes to invest capital successfully,” McComb said. “Some of the questions are fairly obvious, but fundamental. What is the investor’s track record? Is it in the same sector for which they are trying to raise capital? Are the principals and investment team the same people who are responsible for the track record they are claiming as the firm’s? Does the team contain members and operating partners with relevant industry experience? Does their network mean they can source differentiated deal flow?”

How a sector’s overall performance informs LP appetite

Although the Covid-19 pandemic period has seen some industries perform well, such as technology, while others such as leisure and hospitality, have been heavily impacted by lockdowns, LPs have continued to focus on long-term GP track records rather than rushing to get behind less familiar managers that happen to be targeting deals in hit sectors.

Guen said investors wanted to “see experience and repetition of success”, and were focused on clarity around strategy, consistency of returns, and clear views on where capital can be deployed.

Guen added that there were, nevertheless, points in the cycle when LPs found themselves underweight on particular sectors and that at the current time most investors needed to increase exposure to technology.

Building this exposure to technology, however, was a nuanced exercise. In addition to the emergence of “laser specific” technology funds in the US, traditional private equity firms had “morphed themselves” by embracing the power of digitalisation and applying it to their portfolio and new deals. This had the power to completely transform a track record, and provide new avenues for LPs to increase allocations to strategies with technology angles, Guen said.

Stronger returns

McComb said there had been various studies concluding that sector specialists delivered better returns, and that anecdotal observation from his team’s portfolio showed the best performers having some kind of sector specialism. He added that many managers would have more than one specialist area of focus.

Pivoting a strategy away from a sector in decline to a different industry, however, came with its challenges.

“If a sector wasn’t in decline when a manager made investments but is in decline now, there have probably been poor results unless they were really good or really lucky. Those managers will have a tough go of it,” McComb said.

Guen said firms with digitalisation capabilities, however, did have the scope to drive returns across multiple sectors, including less-fashionable industries.

“If you look at the technology companies that are driving the US public markets today, they do serve the consumer. If you can bring that type of energy into your portfolio, you can deliver some great results,” Guen said. “Managers are looking at how digitalisation can enhance an existing strategy, and how every portfolio company has cutting edge technology in the way it operates.”

How to set up a sector specialist firm

Sector specialist firms have followed different templates when it comes to building teams, with some going down the operating partner route, while others have focused on developing sector knowledge with deal teams. Mid-market and mega-market firms have also taken different approaches to bedding in sector specialist skills.

McComb, however, pointed out that the success of any private equity team came down to the same key fundamentals, across all investment strategies.

“I don’t think the template for setting up a sector specialist firm is that different from setting up any kind of private equity firm. If you are an emerging firm you really need to give thought to what sectors you are targeting and what your competitive advantage is within that sector niche,” McComb said. “In my opinion, the key to success is having the right human capital. It is a people-oriented, relationship-driven business. It has been like that for the last 40 years and that is how it is going to continue to be.”