Industry players warn of conflicts in evolving GP-LP relationship - AVCJ Forum

To illustrate this point, Peter Wiggs, CEO of Archer Capital, gave a hypothetical example: If a GP were seeking to raise $1 billion and had $3 billion in demand from 70 LPs, reaching the target should be reasonably straightforward. But if just five LPs accounted for two thirds of the previous fund corpus and three of them decided not to re-up for macro reasons, the GP would be exposed, potentially threatening the entire fundraise.

"We talk about deeper relationships, but let's face it, contractually the relationship only exists for one fund. No one is getting put options back to LPs in subsequent funds. It's probably solvable but there are conflicts," Wiggs told the AVCJ Australia & New Zealand Forum.

Nevertheless, more concentrated private equity portfolios are increasingly the norm. Michael Weaver, manager for private markets at Sunsuper, noted that 20 GPs now account for more than 90% of the superannuation fund's portfolio. Meanwhile, Future Fund has 30 GP relationships globally, but Steve Byrom, head of private equity at the Australian sovereign wealth fund, said that only 20 or so are considered core partnerships.

"LPs might have had 200-300 GPs in their portfolios. Today they want 50 or 20, or some number in between the two," Byrom added. "They are trying to bring their core groups down. To do that they want to put more capital with their preferred GPs so they are trying to push them into strategies that are tangential to what they do in their core business. We are seeing some drift in these pure play shops."

This approach has helped foster the emergence of GPs that Byrom describes as "almost a relative play." These are diversified managers running large pools of capital in order to meet the needs of institutional investors – typically US pension funds – that want to increase their allocations to private equity because it is seen as more likely than other asset classes to deliver returns above a mandated level. However, the low interest rate environment means these return expectations are being pushed downwards.

"At the top of the market we are seeing more and more competition. It is harder for GPs to get deals done, but there is more money coming their way, so more dry powder is accumulating," said Weaver. "The US pension funds are doing what is right for them, but it is making it more challenging, particularly at the top end of the market for those sorts of deals to get the returns we would expect private equity to generate over time."

Adrian Kerley, investment manager for private capital at Commonwealth Superannuation Corporation (CSC), concurred that the macro environment is making it harder to find GPs where there is enough conviction that the absolute return will justify the risks of having private equity in the portfolio. "It's getting tougher, LPs need to be a bit more creative, and that's why a lot of us are going down that path of trying to build relationships that will build over time," he said.

These deeper, supposedly more enduring relationships can display a variety of characteristics. There is more communication – LPs might in certain cases try and use their global networks to offer guidance to GPs on broader investment trends or even to play a direct role in helping them win deals – but the dialogue also stretches beyond how value creation can translate into returns. Issues such as co-investment, governance, reporting and transparency are increasingly prevalent.

Wiggs identified two key elements to successful GP-LP relationships: mutual trust and clear metrics as to what each party is going to do. While PE is strong on the former, it could do better on the latter. "We are seeing a bit of a transition from an absolute returns, net-net returns focus to a very much broader set of guidelines for what it is to be an LP and a GP," he said. "When I first got into this game it was, ‘Tell me what your IRR is and your money multiple is,' and that was probably the end of the conversation."

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• Topics
• Australasia
• Performance
• GPs
• LPs
• Australia
• Archer Capital
• Future Fund
• Sunsuper
• Commonwealth Superannuation Corporation (CSC)
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