Investors emphasize GP-LP alignment - AVCJ Forum

Hideya Sadanaga, head of private equity at Japan Post Bank, noted that he is continually challenged by his board as to how long the current run of robust performance can be sustained. “Returns are great across the board; it almost seems like nothing can go wrong. But I am pretty sure something will go wrong at some point in time, and we will look back and ask, ‘Why did we do that?’” he said.

“It is important that GPs and LPs are aligned to maximize those returns, especially as we go into more challenging times ahead.”

The notion of aligned incentives was generally endorsed by fund managers and institutional investors participating in the same panel. However, Sarah Farrell, head of private equity for Europe and Asia at Allstate Investments, also stressed the importance of GPs having skin in the game and the economics with the economics within the GP being distributed to those who create the most value.

Ownership of the GP is another consideration. Allstate is willing to support managers that introduce new strategies where there is a clear rationale – for example, where there is a demonstrable ability to add value or a need to retain key talent by creating new leadership opportunities – but it declines to back listed PE firms because that structure “runs the risk of getting into asset-gathering mode.”

Kurt Björklund, a managing partner at Permira, which is not listed, claimed the fact that public markets place a higher valuation on predictable management fee streams than unpredictable carried interest, creates a natural dilemma: the emphasis on absolute returns, which underpins the GP-LP relationship, could be diluted by a desire to please public market investors.

“There is a pyramid of risk-reward in the market and if you want to get that top end of the pyramid you probably do that better as a private partnership that is really aligned with LPs strategically,” Björklund said.

Permira works with approximately 200 relatively large investors that are longstanding players in the asset class, seeking a balance between diversification and stability. Nevertheless, working with big-ticket LPs is no guarantee that interests will be aligned.

Francois Aguerre, a partner and head of origination at Coller Capital, explained that his firm turned down a $1 billion fund commitment because the investor had specific requirements for a separately managed account (SMA). Coller has traditionally opted for a single structure with common terms, and it decided that comprising this approach would be destabilizing.

LPs ramping up direct investment activity is another potential point of conflict, although Björklund and Raymond Svider, a partner and chairman of BC Partners, noted that few of these programs stand the test of time. Where there are concerns about competition, curbs are placed on communication.

Large investors also tend to make up the bulk of LP advisory committees (LPACs). Aguerre pointed to a survey conducted by Coller in summer 2020 that found two-thirds of LPs believe LPACs do not provide equal representation to all investors in a fund, even though most claimed that LPACs generally do a good job.

Permira’s Björklund noted that these large investors are the best-informed and best-resourced, and they have the longest experience and deepest relationships in the market. This makes them helpful partners and counterbalances. “I can’t think of a single decision that has been triggered by the LPAC meeting that would have been against the interests of smaller LPs,” he said.

Allstate’s Farrell added that, while she acts in the best interests of her platform as a fiduciary of capital, this doesn’t mean non-LPAC members are getting shortchanged. However, she admitted that some pension funds are so “sensitive about anything that could be perceived as conflicting,” they vote down proposals even though pursuing them might be commercially beneficial.

The BC Partners solution is to create a broad church. The likes of sovereign wealth funds, pension funds, insurance companies, and asset consultants are represented on the LPAC to ensure a wide range of voices are heard.

Secondaries are inevitably dragged into any debate about alignment because three parties are involved – exiting investors, entering investors, and the fund manager – and tensions can readily emerge over pricing and terms. Sadanaga observed that establishing whether the proposed price is a fair one “is a challenge for us” in the absence of third-party validation.

Allstate’s Farrell added that potential conflicts require careful management, highlighting alignment of interest in the new deal and how much carried interest the GP rolls over. However, this doesn't necessarily mean LPs are reluctant to participate.

“There’s frothy pricing, but you have high-quality GPs doing single asset secondaries with their trophy assets," she said. "These are assets the sponsor knows, where they have executed value creation and have high conviction on the next step in value creation.”

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• Topics
• LPs
• GPs
• Fundraising
• Secondaries
• Asia
• AVCJ Events
• Japan Post Bank
• Permira Advisers
• Coller Capital
• BC Partners
• Allstate