Live from SuperInvestor 2017, our panels and speakers in the Fundraising Summit discuss the top trends in fundraising: alternative structures, how to access top tier funds and how to negotiate terms.
Among the trends seen in the private equity industry in the last few years is the increasing sophistication of LPs, and their investment in alternative structures. Is this trend set to continue?
“Investors and GPs are looking for something new and creative,” suggested Warren Hibbert, Managing Partner at Asante Capital Group, and part of a panel assembled to discuss such matters at SuperInvestor 2017 in Amsterdam.
But Warren didn’t think that alternative structures would become the new normal. “There is a broad spectrum of structures being used, but they’re always going to be a small part of a wider eco system, and the preserve of GPs and LPs that work at scale,” he said.
Why has demand increased to such a degree? Thomas McComb, Portfolio Manager at JP Morgan, said that one of the primary drivers was that it offered a cost-efficient approach to private equity investing. There were also higher returns on offer: “If you look at the fund return universe, we rarely lose money on funds, but you rarely get high returns. On the co-invest side, there is a much higher variance of return,” he argued.
Another driver for demand, according to Richard Clarke-Jervoise, Partner at Stonehage Fleming Investment Management Limited, was the ability to pursue a particular strategy, and pick and choose investments.
Strategy drift
There were certain risks to consider, though, felt the panel.
Investors fear that the influx of capital could cause a strategy drift by GPs, potentially damaging investment returns.
According to Thomas, strategy drift was something that J P Morgan took into consideration when making investment decisions: “It’s in the nature of the general partners to want to raise more funds. Co-investment is one way to do it. It does impact our thinking when we assess value.”
Accessing top tier funds
A common complaint of LPs was their inability to access top tier funds.
Yolande van den Dungen, Senior Portfolio Manager, Alternatives at SPF Beheer suggested that being in constant dialogue with managers - not only at fundraising time - was key to overcoming this issue.
Brian Frieser, Senior Portfolio Manager, Private Equity & Infrastructure at MN agreed, adding that it was equally important to manage GP expectations: “When we don’t think a fund is good enough for our portfolio, they will receive a quick no, when we like it, we try to go in quickly.”
Managing expectations was particularly important, because MN had a “relatively long investment process compared to others”.
LPs also had to differentiate themselves: “We can come in with quite large tickets,” said Brian, a fact which he felt helped them get to the head of the queue.
“We do it by really understanding ourselves; understanding the selling points of our organisation” stated Spencer Miller, Director at SJF Partners.
A strategic approach by LPs also worked well. Mapping the LP base of the hard-to-access funds, and using existing relationships with the investors already there were routes some had taken into the top tier funds.
But Lynn Nguyen, Acting VP/Head of Investment Funds at OPIC reminded us that it was a two-way street: “You not only want good fund managers, they also want good partners,” she said.
The importance of due diligence
Was there a risk that, in the current hot environment, LPs would forego due diligence?
Spencer Miller felt that there were elements of this at play in the current market, including GPs leveraging excess demand to push back strongly on too many data requests.
“The challenge is that there are very different types of investors,” he explained. “Some have mature portfolios and long standing relationships, and certain issues will be hot buttons, but others have huge quantities of new capital with immature portfolios and are desperately trying to get into brand names.” It was this latter type that were more likely skip on due diligence, not something any of the LPs wanted to see.
For Yolanda, proper due diligence was imperative: “It’s a lot of lists with questions that a GP receives from us. It’s really a no go if we don’t get comfort that alignment is good,” she explained.
Equally, there were no short-cuts for Lynne, who laid some of the responsibility at the feet of GPs. “From a GP perspective, if you can’t deploy that amount of capital and people are clamouring to get into your funds, you should probably start saying no to LPs that are not bringing added value.”
Terms and negotiating
With the hurdle of getting access dispensed with, how should LPs go about the negotiating process?
Recent history has had LPs very much in the driving seat, but many feel that the pendulum is beginning to swing back.
“We are in a market where the GP is in the ascendancy, but I think that this is only in the case of the larger players in the market,” stated Sam Kay, Partner, Head of Investment Funds at Travers Smith.
“Actually, there is a bit of a bifurcation; the have and have-nots, even on the GP side. There are groups that do have to respond very carefully to LP demands,” he added.
Marc der Kinderen, Managing Partner at 747 Capital was a bit more circumspect: “Today we can ask for more from our GP, but that doesn’t mean we’re going to get it,” he laughed.
One of the clearest changes seen in the last few years, they all agreed, was the offset of fees. “Funds still try to make a claim that they should be able to retain part of those fees, but they really do have to present a very clear and strong case to LPs,” felt Sam.
Peter added that, in general, “all of the terms have evolved, people understand them more.”
That said, the new levels of negotiation were a double-edged sword, according to Sam. “The establishment costs are increasing because of the bespoke terms demanded by LPs. For the larger funds, if you have 100 investors, you’re going to have two to three hundred pages of provisions on top of the LPA. It’s becoming a burden on the industry.”
