Private Equity’s “Recency Bias” Problem: Lee McCabe on Pattern Overextension

In a recent LinkedIn post, Lee McCabe critically examines a pervasive strategy within private equity: the tendency to excessively copy recent successes, a phenomenon he terms “recency bias.” McCabe argues that this often leads to “pattern overextension,” where the industry mistakes a single successful deal for a broader, repeatable strategy, ultimately diminishing future returns.

McCabe highlights how quickly a successful investment can become a template for numerous subsequent deals. He observes:

“The last deal that worked quickly becomes the template for the next five. One healthcare services platform performs well and suddenly everyone has deep conviction in fragmented healthcare services. One software roll up lands nicely and now every mediocre vertical SaaS asset is apparently a strategic priority.”

The Illusion of Foresight

The post delves into how private equity firms often reframe successful outcomes as strategic foresight rather than recognizing the influence of specific contextual factors like timing, price, or scarcity. According to McCabe, this reinterpretation leads to the creation of a “playbook” or “sector thesis” that attracts more capital and competition.

“Success in private equity has a strange way of being rewritten as foresight,” McCabe writes. “A deal works, and the industry immediately decides it was not one good investment made in a specific context. No, it was evidence of a broader repeatable truth.”

This crowding effect, as McCabe describes it, typically occurs when valuations are already elevated and the initial advantage has dissipated. The influx of capital, driven by imitation, often leads to higher entry multiples for subsequent investors.

From Strategy to Auction

McCabe points out that what might have been a unique opportunity becomes an “auction process with prettier slides” as more firms chase the same theme. He suggests that the industry’s “conviction” in these crowded trades is frequently just “delayed mimicry.” The real challenge, in McCabe’s view, lies not in replicating past successes but in identifying when a promising idea has become too widely accepted.

Identifying True Edge

The author posits that the most successful firms are those that can discern when an attractive theme has reached its peak popularity within the private equity landscape. “The best firms are not the ones that copy the last winner fastest,” McCabe asserts. “They are the ones that know when a good idea has already been fully socially accepted by private equity, which is usually a decent sign the return profile is about to get much less interesting.”

McCabe concludes that recency bias can create a false sense of intelligence within the industry, leading firms to overpay collectively. This “overpaying in formation” is a direct consequence of chasing trends rather than identifying unique, context-specific opportunities.