LPs lose love for private equity?

This regular survey of global LP opinion, this time taking in some 108 private equity investors, 20% of them from Asia Pacific, found that overall, the institutions polled were disappointed by the performance of their private equity commitments, and felt especially that some of the key promises of the asset class – low correlation to public markets, and outperformance of those markets – had not delivered in the crisis.

Furthermore, Asia Pacific and European LPs seem to be some of the most disappointed. A clear 50% of respondents from both regions said they viewed private equity less favorably than before the crisis, and none said they viewed it more favorably. In North America, meanwhile, only some 28% said their views of private equity had worsened, and a few even viewed it more favorably post the crisis.

 

Reasons for disappointment

Hiro Mizuno, partner at Coller Capital, points out the lesson for GPs. “When global investors started making private equity allocations, their thesis was less correlation and outperformance. Both of those have been challenged,” he emphasized. And this is particularly important when private equity teams within large LPs are having to defend existing allocations to their boards or other overseers.

“The LPs have had trouble keeping the confidence of their trustee boards and others who make allocation decisions,” he adds. “LPs are struggling internally, as well as externally.”

The reaction against private equity is dictated by specific disappointment at actual performance too – rather than mere sentiment. And once again, Asia Pacific LPs were some of the most disappointed. Over 75% of them in the poll said that they were disappointed or very disappointed with the recent performance of their private equity portfolios. Their North American peers, contrastingly, were over 60% satisfied with their portofolios, and a few even very satisfied.

Mizuno views the sharply differing sentiment as partly a question of investment vintage and familiarity with the asset class. “For most Asian LPs, private equity portfolios started building up in early 2000. The market crashed before they started enjoying real private equity returns,” he observes. North American LPs, however, already had years, if not decades, of good returns that may have helped their comfort level. “I think they got hit as bad as the Asian LPs, but they also had a previous track record that yielded great returns.”

However, Mizuno adds, Asia Pacific LPs’ poor experience of private equity performance has nothing to do with the maturity and sophistication of their investment programs. “Most Asian LPs I know invested most of their portfolios through funds of funds, which are supposed to be the most experienced private equity investors. It’s much more attributable to the vintage than the experience of managing a portfolio.”

 

Positive spin

The more positive Barometer findings are that, despite their recent disappointments, private equity investors seem prepared to maintain their existing allocation targets, with only some 11% of LPs planning to reduce their percentage of assets in private equity over the next 12 months. This is a much higher figure than 12 months ago, but still a far smaller shift than the reported sentiment might suggest.

GP optimism about that conclusion might have to be tempered, though, by some reflection on the nature of LP commitments – at least, in Asia. As Mizuno explains, among Asian LPs, “vintage 2008 funds were very big and their initial commitment was huge. On the other hand, they haven’t drawn much yet.” Therefore, “Asian investors probably have more unfunded portions of their commitments … This doesn’t have much implication for Asian LPs’ future commitment to private equity.”

Also, LPs broadly agree that the global economy is on track to resume sustained growth c. mid-2011, with Asian LPs perhaps slightly more pessimistic about the speed of recovery. And they overwhelmingly expect 2010 to be a good or great vintage year, with only 2% expecting a poor vintage. As a result, they are ready for a ramp-up in capital calls in 2010.

 

Takeaway for GPs

Implications of these and other findings are that GPs cannot take too much comfort from the unchanged headline allocation plans, especially in Asia Pacific. Within the institutions, private equity is on difficult ground against the other asset classes. “The struggling investors are those who came into the asset class at the peak of the bubble,” Mizuno says. “For them, the internal debate will be much more challenging.”

LPs are now much more concerned about poor reporting and transparency, and alignment of interests both within firms, and between GPs and LPs, the Barometer found. The latter issues are basically a subset of the overriding concern with transparency.

“All these conflict of interest issues are really about the transparency of the structure and the incentive system of the fund,” Mizuno maintains. “To keep persuading their trustee board or committee to keep committing to private equity, they seem to demand better reporting from GPs to explain their portfolio.”

The lesson for GPs is clear: concerns about transparency and accountability have not gone away, and GPs will have to move to address these to offset some serious LP disappointment.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Fundraising
• LPs
• Coller Capital
• Hiromichi Mizuno