There has perhaps never been a more dynamic time to be a Limited Partner in private equity; the performance and maturation of the asset class over time has served to drive the asset class’s popularity among investors. At the same time, the landscape for GPs is changing driven by mounting competition, climbing deal prices and record levels of dry powder.
It’s against this backdrop that Monument Group recently hosted a “roundtable” lunch for 30-plus of our Limited Partner network in London. Among the attendees were investment professionals from family offices, pension funds and funds-of-funds. Prior to the event, we asked the attendees to help shape the programming by proposing the topics and issues that are influencing their day-to-day thinking behind manager selection and how they will allocate capital in the months and years ahead. At the event, we also took the opportunity to conduct an informal live poll.
What follows is not necessarily a comprehensive recap, as the conversation also touched on many trends, but we wanted to highlight some of the issues that stimulated the greatest debate.
With record levels of capital dedicated to co-investments in 2018, it’s unsurprising that co-invest opportunities have helped to reshape priorities among certain LPs. With a wide cross-section of investor types present, the discussion reflected a range of attitudes toward, and differing experiences of, co-investments. For some LPs co-investments have become an essential part of their private equity investment strategy with some investors commenting that fund commitments alone do not make sense given the fees.
As well as averaging down fees, many of those making co-investments also highlighted their ability to cherry pick investments as a primary reason for co-investing. A caveat, though, was that for those without access to steady deal flow, being too selective and less dependable could land an LP at the back of the line the next time an opportunity is presented.
The key takeaway, though, is that co-investments do indeed have some bearing on whether an LP commits to a fund with a significant minority of the room saying they’d be less likely to commit if they weren’t granted co-investment rights.
Fund size inflation
Among the biggest issues cited about the current fundraising environment revolved around fund-size inflation – or, more specifically, fund-size inflation without a clear rationale.
Investors are typically open to increased fund sizes when there is a clear strategic reason for it; for example moving into a new region or incorporating a new focus area or specialisation into the larger strategy. Increasing fund size purely to increase AUM, however, is not so well received. This perhaps reflects the long-held perception that funds which rapidly escalate in size in the mid-market space often underperform despite recent data suggesting this is no longer the case.
The topic of first-time funds divided the opinions of those in the room, and there was a split down the middle between those who actively invest in first-time funds (or at least want to) and those who never or rarely consider debut funds. Interestingly roughly a third of attendees believe that inaugural funds are typically the strongest performing “Roman numeral” of fund managers over time.
Despite this sentiment, the backlog of existing firms pursuing re-ups, particularly in the mid- to large-cap segments in Europe, means that first-time funds may have to wait until later in the year to attract LP attention.
Virtually all of the LPs in the room said they are taking a more active role in promoting diversity and inclusion among GPs. Several noted that they are incorporating these factors into the due diligence process. The majority have adopted a pragmatic, incremental approach that aims to encourage GPs to improve their practices, while monitoring the extent to which they do so.
The risk of a downturn wasn’t far from the thoughts of those in the room. That being said, LP commitments to private equity were expected to remain robust in the event of a market correction. Well over half said that public markets would need to fall by at least 20% before the denominator effect – the point at which their PE portfolio value would exceed their target allocation – influenced their PE commitments.
In the event of a downturn, around half of LPs said they would look to invest in value-oriented private equity strategies, while nearly one-third would invest in distressed strategies. Given the relative lack of value and distressed players in Europe compared to say the US market, if there is a downturn, there could be plenty of scope for product innovation.