Do Cross-Border Investments Boost European Buyout Fund Returns?

The global private equity (PE) industry is booming with fundraising being higher than ever and deal volume closing on the pre-financial crisis peak. However, as valuations are also at record-highs, and the amount of dry powder is increasing, it seems that the increased competition and capital flows pose challenges for funds to find good deals. This may hold especially true for buyout funds for which assets under management have been growing the fastest. In the efforts of sustaining returns, buyout funds may be inclined to look across borders for good deal flow. In my master’s thesis, I investigated the implications of cross-border investing on European buyout fund performance.

In my studies at Aalto University’s Industrial Engineering and Management programme, the primary focus is on strategic, operational and financial topics. As the PE practice combines aspects from these areas, it aligns well with my interests, and therefore I wanted to study it further in my master’s thesis. While looking for a topic, a common theme that kept coming up was the interest in understanding which investment strategy leads to high fund performance in buyout funds. Available data and limited existing research allowed me to study whether cross-border investing could be such strategy.

Prior research has associated cross-border investing with challenges related to cultural distance, information asymmetries and idiosyncrasies of operating in foreign markets. On the other hand, the differences in institutional environments of countries may provide opportunities for funds. In addition, the challenges can be mitigated by gaining knowledge about the local market through engaging in club deals, gaining multinational or country-specific investment experience, or by setting up local offices. Since returns have been found to increase as investing opportunities improve, and the challenges seemed to be more related to deal flow than succeeding in investments, I expected the performance to be positively related to the share of cross-border investments in a fund.

I tested my hypotheses on data consisting of 270 European buyout funds raised between 2000 and 2010. The results implied that the effect of cross-border investment share is not always positive but rather depends on a few circumstances as follows:

  • A high focus in cross-border investing seems to increase value for large buyout funds but for small funds the effect is negative. Large buyout funds might have better deal flow looking across borders due to a limited number of big-enough prominent deals in their domestic markets. Large funds are also likely more experienced in international investing.
  • Fund performance is positively related to the local office deal share in a fund. This implies that worse performance is associated with pure cross-border investments and that cross-border settings can increase value if engaged in through a local branch.
  • The share of cross-continent investments in a fund has a positive relationship with fund performance suggesting that investments made to geographically further targets might perform better. This can be argued by possibly more diligent screening and monitoring of such targets, although more research on this explanation is warranted.

Although the quantitative analysis provided significant results, perhaps the more interesting viewpoints and anecdotal support came from the few interviews I conducted. What surprised me the most was that industry professionals found cross-border investing as a difficult source for deal flow and emphasized the importance of local presence and positioning. All in all, a key learning from the discussions was that PE business is very much based on trust and credibility earned through building relationships, connections and networks with all stakeholder, which is imperative for finding proprietary, high-performing deal flow.

About the author:

Joel Heinikoski
The honourable mention on FVCA’s master thesis competition.

Joel is a consultant at Spring Advisor working on a wide scale of projects from strategy and operations consulting to financial advisory. Previously he has worked at Deloitte Consulting and RELEX. He graduated from Aalto University School of Science in summer 2019, where he studied Industrial Engineering and Management with a major in Strategy and Venturing.