LPs worried about denominator effect as capital calls rise - survey

Nearly two-thirds of respondents said they were worried about exceeding their policy target for private equity. “It is hard to unwind current positions in PE. As public markets go down, we see a denominator effect. The last thing we want is to have a run on cash and have a large amount of capital called to fund investments,” one LP observed.

Over half said that the pace of capital calls has accelerated, although fewer than 10% had seen a dramatic increase. There is a degree of uncertainty as to what the capital is being used for as GPs engage in “anticipatory drawdowns” to get headroom in the event of a liquidity crisis. This is in addition to capital cushioning activity at the portfolio company level.

Questions have been asked throughout the industry about subscription credit lines taken out against undrawn capital commitments from LPs. The survey found that just under half of LPs have seen changes in capital calls during the fortnight ended March 26 that related to subscription lines or shifting market conditions driven by COVID-19.

Various explanations were given for this behavior. They included GPs hitting the maximum indebtedness level permitted in the limited partnership agreement (LPA) – and calling capital to pay off earlier investments – paying down subscription lines to ensure they have the ability to borrow if need be, and maxing out lines now in case lenders don’t renew them or reduce capacity.

As for new commitments to the asset class, most LPs expect to see no change in policy or are still in the process of evaluating their positions. A further 19% said they were pausing on all or nearly all new commitments, 15% are concentrating on re-ups with core managers, and 11% are focusing on opportunistic strategies such as distress or secondaries.

First-quarter valuations are expected to have a significant impact on commitment pacing plans for 2020 and beyond, but LPs are concerned that the numbers will be hard to interpret. “How much do we haircut NAVs [net asset values]? We have to look back at past dislocations,” was one response. “Using Q3 2019 NAVs in the upcoming Q1 2020 exposes how flawed the lagged method is.”

More than 80% of LPs are receiving more frequent communications from GPs about portfolio company status, with 60% saying these communications are detailed in nature.

LPs are willing to consider amendments to capital recycling provisions to support existing investments, though some want close oversight of this activity to prevent abuse. Meanwhile, only a few have been approached about participating in rescue financing for portfolio companies, for example through equity cures or subscriptions to convertible notes. These are evaluated on a case-by-case basis, with potential conflicts of interest among the considerations, the survey found.

ILPA has more than 570 LP members from 50 countries representing in excess of $2 trillion of private equity assets. More than 100 shared their views on the impact of COVID-19 through a combination of polling questions and unprompted posts.  

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