As we entered a new year amid heightened political and economic uncertainty, the vision of what 2020 holds for private equity is anything but 20:20. With private investors sitting on a record-high $1.45 trillion of dry powder at the end of 2019, Monument Group gathered around 40 members of its close LP network for a roundtable in London to discuss how LPs will be approaching their allocation decisions over the coming year.
Among the attendees were investment professionals from family offices, pension funds and funds-of-funds who we asked to help structure the agenda by proposing the very issues shaping their views on manager selection and capital allocation. On the day, we took the opportunity to conduct an informal live poll. Here are some of the topics that made for the most stimulating discussions and debates:
In recent years, technology has consistently been the most popular sector for LPs’ allocations. In 2020, in a more nuanced turn, LPs are seeking to ensure that portfolios are taking advantage of technology advancements in all sectors. Perhaps a sign of market turbulence, investors displayed growing interest in business services and healthcare, sectors that are typically perceived to be more insulated against economic shocks. Importantly however, investors are still looking for GPs investing in these and other sectors to demonstrate a solid understanding of technology to maintain their competitive edge.
Co-investment: the new normal?
There was clearly a healthy appetite for closer collaboration with GPs, with the majority of LPs present looking to funnel at least 20% of their private equity commitments into co-investments over the next two years. Attendees discussed a host of motivating factors driving this rise in popularity, including the averaging down of fees and greater influence on deal selection.
LP demand for co-investments currently exceeds supply by a considerable margin, according to the McKinsey Global Private Markets Review 2019, and GPs are being prompted to change their strategies to close this gap. This proved to be a popular discussion point amongst attendees.
Driving operational success
When it comes to the most attractive areas of GP innovation, many LPs continued to point toward operational value-add – specifically at managers that pull the levers to create alpha through hands-on portfolio management. These investors are keen to understand the drivers of operational value creation that will be consistent over time, whatever the economic weather.
Others highlighted the more nascent area of environmental, social and governance (ESG) as well as new approaches to deal sourcing as key factors of differentiation particularly when so many GPs are talking about their operational credentials.
The consensus, however, was that managers should be availing of all resources within their
control to reduce the risks of failure and increase the chances of success. And that covers
everything from systems and processes to ESG.
ESG: hype versus reality
Interestingly, the vast majority of attendees said they would not sacrifice returns for ESG improvements. In fact, the broad view in the room was that they do not have to and that enhancing ESG should be a driver of superior returns when done thoughtfully. LPs concurred that by prioritising ESG, all businesses across sectors can benefit from a more valuable brand, improved employee attraction and retainment and greater customer loyalty, making for a more sought after investment at the end of a fund’s hold.
That said, LPs are wary of ESG window dressing when looking at funds and diligence is
becoming more rigorous, with certain investors starting to make commitments contingent
upon tangible improvements to GPs’ processes. The days of simply paying lip service and
greenwashing look to be numbered.