It may seem self-evident that a seasoned veteran of a specific sector ought to generate better outcomes than a less experienced player but there are few studies that prove it. Here we share 3 three reasons why specialisation matters:
Reason 1: Return on Investment
A study conducted by Cambridge Associates found that sector specialists returned an aggregate 2.2 times cash on cash and a 23.2% gross annual return, outperforming generalists that returned an aggregate 1.9 times cash on cash and a 17.5% gross annual return. The study cited reduced information asymmetries and reduced uncertainties as the two main sources of advantage. They also argued that specialized investment firms possess a deeper knowledge of the competitive environment and can therefore both select potentially superior performers and provide more effective monitoring and advice.
Reason 2: Idea origination
Specialist investment firms are better able to contextualize macro industry dynamics to identify hidden value drivers of opportunities that a generalist might otherwise overlook. Business owners want to see an investor with long-standing relationships, deeply entrenched in a sector. It’s the ability to open doors that others can’t. Furthermore, evidence from our own work at The Education Fund network illustrates that business owners are more inclined to engage in a conversation with someone who demonstrates a level of specialization.
Reason 3: Post Transaction Value
Business owners are naturally more comfortable if an investor can slide into management, roll up their sleeves, and offer advice derived from real-world trials instead of MBA case studies. There is no substitute for experience. A 2007 study entitled “Playing to their strengths? Evidence that specialization in the Private Equity industry confers competitive advantage” shows just that. They found that that specialized investment firms on average yield 4% higher operating profit than non-specialized firms in the 3 years’ post investment.
Specialization matters because it has been shown, through both research and anecdotal evidence, to enhance each step of the investment lifecycle. Investors are more confident and willing to give funds, and business owners are more enticed by investors who know what they’re doing. With these ducks in a row, the specialist team can do what has become second nature, build businesses in specific sectors that generate better outcomes.