Seven key takes from the LP Perspectives 2023 Study

PEI’s LP Perspectives 2023 Study showcases investors’ opinions on the outlook for the industry.

After years of almost unstoppable growth, 2022 was a challenging year for private equity.

Inflation, absent for decades as a major economic concern, began to rear its head as covid waned, then skyrocketed this year after Russia’s invasion of Ukraine upended global energy markets. Unsurprisingly, perhaps, rising interest rates, surging inflation and the risk of recession top LPs’ list of concerns, according to Private Equity International’s LP Perspectives 2023 Study.

Amid a worsening macroeconomic environment, fundraising has become more difficult for many firms. This year the survey highlights a significant rise in the proportion of LPs intending to invest less in private equity. Still, the sense of crisis should not be exaggerated. Indeed, the fact that a growing share of investors are overallocated to private equity is a sign of the asset class’s success.

At the end of another volatile year, PEI’s annual investor survey takes stock of LP sentiment as the private equity industry adapts to a changing and turbulent world.

Momentum slows

After years of steadily increasing allocations to private equity, LPs appear to be taking a somewhat more cautious approach amid global macroeconomic uncertainty. Only 28 percent of LPs plan to increase the amount invested in private equity in 2023 – a sharp drop from the 46 percent that said they planned to do so in the 2022 study. The share of respondents planning to invest less has also jumped, from 7 percent to 21 percent. The results reflect the fact that almost one-in-four LPs is overallocated to private equity.

Interest rate anxiety

The evolution in LPs’ concerns provides a snapshot of how the macroeconomic picture has drastically changed in the past year. Twelve months ago, interest rates were barely on the radar of LPs. Today, 75 percent say rising rates are one of their main concerns, with 66 percent saying the same of higher inflation. But investors seem optimistic that the worst of the pandemic is over – just 6 percent identify covid-19 as a main concern, down from 63 percent last year.

Room for improvement on ESG

Managers are never slow to highlight their ESG and diversity, equity and inclusion credentials – but it appears that LPs are not easily impressed. Only 5 percent of LPs rate GPs’ performance on ESG reporting as ‘excellent’ – with an even smaller proportion saying the same of other aspects of ESG. In particular, the results suggest more work is needed on DE&I. Some 14 percent of LPs believe GPs are doing a ‘poor’ job at DE&I in their own firms.

Market cools on subscription lines

This year’s survey sees a significant change in sentiment towards subscription credit lines. Only 31 percent of respondents expect GPs’ usage of subscription lines to increase, down from 51 percent last year. Alex Scott, a partner in the European private equity investment team at Pantheon, says attitudes among LPs vary. “There is no consensus and it very much depends on the investor’s attitude to leverage, and expectations or objectives in terms of risk and return.”

Living with overallocation

The share of LPs that are overallocated to private equity has grown from just 12 percent in our 2019 survey to 24 percent this year – reflecting how private markets have outperformed listed equities over this timeframe. Given reduced dealflow, it may be difficult to reduce exposure to private equity at present. But a large share of LPs appears somewhat relaxed about overallocation – 44 percent are willing to remain overallocated, while another 25 percent respond by adjusting their targets.

Secondary options

Secondaries activity looks set to increase in 2023, mainly because more LPs are looking to sell – perhaps because of being overallocated to private equity. The share of LPs planning to sell PE fund stakes on the secondaries market has grown from 15 to 22 percent, while the proportion of LPs intending only to buy on the secondaries market has risen by 2 percentage points. A further 6 percent of LPs plan to both buy and sell on the secondaries market, unchanged from 2022.

Rise of GP-led secondaries

GP-led secondaries funds have grown in prominence recently. Deal volumes more than doubled in 2021, according to adviser estimates, as sponsors turned to GP-led transactions as a means of holding their prized assets for longer. “A less optimal environment for exits will likely see more GPs turning to the GP-led market as a route to maintaining ownership while providing interim liquidity for LPs,” adviser Lazard wrote in its latest Sponsor-led Secondary Market Report. However, when it comes to dedicated GP-led strategies, so far only a minority of LPs are convinced – 61 percent of respondents say they have no plans to invest in GP-led secondaries funds.