According to a new study from London-based private equity researcher Preqin, the largest buyout funds saw returns decline by 31.4% in 2009. That’s versus a smaller 16.7% decline for mid-size funds and a 12.9% decline for smaller funds.

Preqin used fund-level performance data taken from Preqin Performance Analyst Online – the world’s most comprehensive source of buyout, venture and other private equity performance, with fund level metrics for 4,880 vehicles with a combined value of $2.81 trillion (70% of all funds ever raised by value), including 1,184 buyout funds with a total value of $1.31 trillion.

The funds were split by size into small (≤$500 million), mid-market ($501-$1,500 million), large ($1,501-$4,500 million) and mega (>$4,500 million) in order to fully evaluate the effects on different sectors within the industry.

“Our analysis shows that while the effects of the financial crisis have been felt across the whole of the buyout industry, it is the very largest funds that have been most affected,” says Tim Friedman with Preqin. “The data shows a significant narrowing between equity capital being spent by buyout firms and the total deal value, suggesting a drop in the levels of leverage being used to finance deals. With the very largest firms being heavily reliant upon highly leveraged deals, it is unsurprising that the economic downturn is affecting this sector the most.”

Here are the study’s key findings:

• Mega buyout funds are now providing the worst returns over the one-year (-31.4%), three-year (-3.1%) and five-year (+23.9%) periods.

• Large buyouts are the second-worst performing fund type, returning +23.7% over five years, +9.9% over three years and -24.4% over one year.

• Mid-market buyout funds are the strongest performers over five years (+29.3%), and are the second-highest performers over three years (+12.2%) and one year (-16.7%).

• Small buyout funds have performed the best over one year (-12.9%) and three years (+18.6%), and the worst over five years (+21.5%).

• Mega buyout funds were most affected following the onset of the credit crisis, with fund values falling by -9.1% in Q3 2008 and by -21.9% in Q4 2008.

• All areas of the industry saw a drop in valuations in Q3 2008. However, it appears that the bottom has now been reached, and fund valuations are improving across the board. Mega buyout funds actually saw the highest increase in value in Q2 2009 (5.7%).

• By fund vintage year, small and mid-market buyout vehicles are the better performers for the most recent vintage years of 2004 – 2006. For vehicles launched in 2000 – 2003, mega buyout funds tend to be the higher performers. Mid-market funds have performed consistently well.

• Despite recent encouraging signs, there is evidence that LPs are far less keen to invest in mega-sized funds than in the past. In Preqin’s survey of 100 leading investors in private equity conducted in December 2009, just 9% indicated that they would be investing in mega buyout funds in 2010. In contrast 53% indicated a preference for small and mid-sized funds.

• Similarly, investors were asked if there were any fund types in which they had been previously active that they were now avoiding. 37% indicated that they would now be avoiding mega buyout funds after previously having invested in them, with just 5% responding that they would be avoiding small and mid-market funds.

“With many banks much more risk averse than in the past, it has been impossible for the bigger firms to achieve financing using the same kind of leverage as in previous years,” says Friedman. “Not only has financing for new deals been an issue, but financial management for existing investments has also presented a major worry. Banks have been focusing on bolstering their balance sheets, and have been unwilling to accept write-downs or forgive breaches of loan covenants set during more prosperous times, making it extremely challenging to restructure financing for existing portfolio investments. As a result, investors are far more hesitant to commit to the largest funds than in the past, with mid-market and smaller buyouts funds currently providing more appeal.”

“However, there are some positive signs. There have been some recent successes from big buyout firms in the fundraising market, such as Hellman and Friedman with an $8.8bn fund, and Clayton Dubilier and Rice with a $5bn fund. There are also indications that the market for new deals is also improving, with the value of deals done in Q4 2009 ($34.6bn) being the highest since the onset of the financial crisis, and over double that of Q3 2009 ($17bn). With fund valuations now starting to improve, and with debt markets beginning to improve, we would expect that the mega-buyout market will bounce back, and will remain an important sector in the industry. However, it will be some time before the kind of fundraising and deals activity seen in 2006 – 2007 are once again attained.”