The proof is in the pudding. Schroders' private equity has delivered during market stress

Australians' attitude to private equity (PE) has evolved significantly over the past five years, with the sector increasingly embraced by superannuation funds, institutional, and private investors.

Once seen as niche or high-risk, PE is now seen as a legitimate pathway to diversification and outperformance, particularly as listed equities have been volatile and bond markets have been gyrating.

It hasn’t been easy, however, with Schroders’ Head of Business Development for Private Markets, Claire Smith, noting that the education process has taken time and that real outcomes have driven a new appreciation for what PE can offer.

“At the start of the fund [in 2020], I'd say it was very much an educational process. Some people had private equity, but it wasn't such a common mainstay in the portfolio, but there were a few good things happening”, says Smith.

"I think hedge funds had not really delivered how they were supposed to deliver through times of stress. Interest rates came off, so people were looking for alternative ways to add returns to their portfolio, and our fund was quite a fit.

"But what we've really discovered today is that there's a lot more options in the market. There's a lot more different strategies. I'd say the level of knowledge of the advisors and clients we speak to has really increased. 

So it's become a much more nuanced conversation around different types of private equity where people see relative values", says Smith. 

With the Schroder Specialist Private Equity Fund turning five years old, I sat down with Smith to understand how the landscape has changed, the types of opportunities the fund pursues, and how it has been delivering for investors.

I also discovered that investments in private equity, just like with listed equities, will go where the action is, with Smith sharing a current investment in a company that is plugged into the AI theme.

Watch the video above to learn more, or read a summary of the interview below. 

INTERVIEW SUMMARY

A growing portfolio with future upside

Since its inception, the fund has grown from an initial US$50 million to US$2.2 billion, with consistent net inflows allowing it to “naturally average in” over time. 

Smith explains that 50% of capital has been deployed in the past two years, meaning many portfolio companies are still early in their growth journey. 

"They're still going to have time to grow and deliver higher returns", says Smith. 

In terms of performance, nearly 20% of holdings have already exceeded the two-to-three times return threshold typical of successful private equity exits. Smith notes, “The fund is five years old, but the assets within it are a bit younger, so it's still a nice entry point for investors considering an allocation to private equity.”

Triple-layered due diligence drives results

Schroders leverages a rigorous “triple filter” due diligence process to identify opportunities in a vast and complex private equity universe. 

"We monitor about 10,000 GPs or fund managers… then filter down to 5,000 we like, and from those we’ve selected 300 to partner with", Smith says.

The second layer involves those 300 partners sourcing investments on the ground, while the final filter applies additional Schroders-led scrutiny on direct company investments, which make up about 45% of the fund. This multi-layered approach allows Schroders not just to "pick the best managers, but often pick the best companies within that manager’s fund". 

Why small and mid-cap buyouts shine

A clear focus of the fund is on small to mid-cap buyouts – a part of the market Smith sees as undercapitalised and full of potential. 

"70 cents in every dollar goes to the large cap part of the market… but that’s only about 1% of the universe", she says. In contrast, 99% of companies by number are in the small to mid-cap space, offering greater fragmentation and, therefore, more opportunity.

Beyond the numbers, these businesses are easier to scale. “It’s much easier to double the size of a small company than a large one,” Smith explains, and they typically carry less leverage, providing added resilience. 

Despite recent exit challenges in the broader PE market, Schroders achieved “three of our most profitable exits in the team’s entire history” through strategic and secondary sales.

Risk, resilience, and riding megatrends

While acknowledging private equity involves risk, Smith believes Schroders’ approach balances this well. The fund has a lower-than-average loss ratio and a higher proportion of “star performers” – investments returning more than five times capital. 

"Things can go wrong in private equity… but with our triple due diligence filter, it's proven that we're able to minimise risk… and really maximise that potential for returns", she says.

In terms of current themes, the fund recently invested in a data annotation company serving major AI players like Meta, Cohere, and OpenAI. "We quite like that company because [it’s] capturing the theme of AI, but you are not taking a bet on which model is going to be the winner", says Smith.

Geographically, the fund favours Europe for its fragmentation and lower pricing, remains selectively bullish on India, and is opportunistic in China. The US is less favoured currently due to geopolitical uncertainty.

Finally, Smith highlights private equity’s ability to weather market storms. 

"Private equity has corrected less [than listed markets], and when you look at the underlying composition, small to mid-buyouts have been the most resilient", she says. Over 25 years, PE outperformed global equities by 4% p.a. on average, and by 8% during volatile periods.

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Schroder Specialist Private Equity Fund

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