Fundraising: The LP angle

While LPs are often accused of operating with a herd-like mentality, they can differ markedly in terms of internal resources, use of advisors, risk appetite, portfolio construction methods and investment remit. A recent trip to the US that included meetings with several pension funds, endowments and foundations served to underline this fact. Nevertheless, a few themes did emerge.

•  Asian interest

Those that already have exposure are looking to get more and those without a specific Asia allocation are considering how they might achieve one. However, there is a big difference between discussion and action. Even foundations and endowments, which in some cases have license to be bolder than their public pension fund peers, are still reasonably wary about emerging markets. The route from global manager to regional manager to single country manager remains well-trodden, but the journey can be slow. One LP noted that he will routinely spend six or seven years tracking a manager before even considering a fund commitment, citing the relative paucity of Asian GPs with substantial track records.

•  Troublesome trustees

Restrictions imposed by trustee boards vary enormously. Two examples stick in the mind. First, the CIO whose team serves as the investment advisor to multiple pension funds, each of which has its own board and separate decision-making process. Second, the director of private equity who presides over a relatively young program and requires sign-off on any commitment from a board that is unfamiliar with the asset class and doesn’t have much of an existing portfolio to draw upon. One board member responded to a proposal for an investment in an emerging markets real estate fund by observing that there was plenty of real estate in the US. More broadly, fees are a concern for trustees and some PE managers struggle to justify the costs versus other asset classes, although strong performance in recent years has helped.

•  Keen consolidators

Culling GP relationships and placing more capital with a smaller number of managers is a well-established trend among the larger LPs. California Public Employees’ Retirement System (CalPERS) is the stand-out case: between 2005 and 2015, the pension system reduced its number of GP relationships from 275 to 102; and by 2020, it wants to have just 30. However, several LPs with much lower starting points in terms of portfolio GPs still expressed a desire to consolidate. For some, it is a legacy of past performance. They are still trying to wind down or offload multiple fund-of-fund interests with exposure to hundreds of underlying managers, having found that overdiversification is a recipe for underwhelming returns. Others simply want to put less money into funds and more into co-investment.

•  Co-investment questions

Opinion remains divided on co-investment – not so much whether it is desirable as how it can be accessed. For a subset of LPs, notably those that require trustee board sign-off on commitments, co-investment is not yet a realistic option. For others, it is a deal-breaker, with one LP saying he completed two secondary sales last year, largely because the GPs in question didn’t yield co-investment. Limited bandwidth is a common complaint. Even if co-investment opportunities are available, it is challenging for a small team to conduct due diligence on deals while simultaneously managing fund-level relationships. Inevitably this leads to more co-investment via downstream syndication, but LPs do appear to be thinking more seriously about how they can develop sustainable co-investment programs without necessarily increasing headcount.

•  Looking for niches

Private credit is, unsurprisingly, attracting a lot of interest. Real estate and infrastructure are also popular – pretty much anything that generates a yield and help address the j-curve effect (although several LPs were noticeably less keen on secondaries, citing concerns about elevated pricing). Those that don’t already have established venture capital exposure still tend to have strong opinions on it: either they are keen to get involved or they are settled on avoiding it. Getting access to top managers and building up in-house expertise are the major obstacles.

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• Topics
• North America
• LPs
• Fundraising
• USA