As fund terms continue to evolve, the move to more bespoke structures reflects the growth of the asset class. Daniel Parker, the Deputy Chief Investment Officer within Office of Investments at the Texas Tech University System, joins us for a discussion on the trend towards customisation.
What is driving this trend toward customisation? Is it as simple as GPs looking to meet the needs of differing constituencies within their funds?
I think that the key drivers of increasing customisation are a combination of LP investment teams that now have more experience with private equity and the fact that private equity is not just growing pari passu with other strategies. In many cases, private equity is taking a more prominent position in asset allocation plans. While there is diversification of LP constituencies, there is general agreement on the prioritization of risk-adjusted returns. Apart from the different objectives imposed by different types of organisations - SWFs, pensions, E&Fs, family offices, etc. - there are also differences between LPs, including significant variances within categories regarding their governance structures and ability to attract and retain talented investment teams.
What are some of the more concrete examples you could provide that speak to the level of customisation?
The two most significant recent customisations are the evolution of terms and the growth of co-investments. The most surprising development to me over the last decade has been the relentless growth of private equity. I think the managers certainly deserve credit for this growth, but it has also partially been driven by the expansion of regulation in the public markets, one symptom of which has been a marked decline in the number of public companies.
Does this push for customisation reflect a power struggle between GPs and LPs or are general partners simply more willing to — or have the capabilities and resources — to accommodate unique terms for specific limited partners?
I’m skeptical that customisation of terms is driven by anything other than relative power. However, I also believe that private equity GPs should learn from hedge funds and structure their investor relationships proactively rather than reactively.
The market is bifurcated into GPs who have demonstrated success, especially through the DPI multiple (or the ratio of distributions to paid-in commitments) and those who have not - either newer platforms or firms with longer track records but mediocre or mixed performance.
Top-tier GPs are able to dictate terms, but this is a relatively small portion of the PE landscape, as it should be. LPs have also gotten better at understanding GP performance, the drivers of that performance, and which platforms have a reasonable probability of producing favorably differentiated returns going forward. This last attribute is typically based on the right combination of opportunity set, experience, runway and execution discipline.
In your experience, which areas in terms of the LP-GP relationship are most open to customisation?
The only limits are the expertise and imagination of the principals on both sides of the dialogue (GP and LP). At TTU, we use Master Custody Accounts (or MCAs), which is a bespoke approach to each of our fund investments. While we start with a template, each one is individually negotiated. Regarding standardisation, flexibility on a range of economic terms seems to be increasing.
You mention standardisation, which brings up an interesting point, because the trend toward customisation seems to run counter to some of the themes around standardisation that have previously been in focus — specifically, the efforts of the ILPA to create a template for reporting. How does customisation affect these efforts?
As mentioned above, there is an emerging bifurcation of both GP and LP landscapes - the ILPA templates are valuable, especially for smaller organisations with limited resources. LPs with scale and/or expertise as well as supportive governance policies continue to be interested in customisation and even large, successful GPs are frequently willing to engage in those conversations.
Ultimately, where do you see this trend going? In Canada, for instance, many of the pensions have gone and created their own direct-investing PE arms. Is that the logical next step?
I think that would be the logical next step, but that it’s also unlikely to happen any time soon. There are a lot of stakeholders in many organisations who aren’t primarily motivated by investment performance. The Canadian model is an impressive example of what’s possible when organisations commit to building talented teams and give them the independence to execute in a focused way.
Under the spotlight: Daniel Parker
Dan is the Deputy CIO in the Office of Investments at the Texas Tech University System. Prior to this role, he served as an investment officer at Helmsley Charitable Trust, a grant-making foundation based in New York. He also spent time at Citigroup, within the bank’s real estate investment banking group, and at BlackRock, where he was a vice president in the firm’s private equity arm.