Alter Domus on standing out from the crowd

Amid fears of a recession, LPs are favouring skilled owner-operators, says Tim Toska, global sector head for private equity at Alter Domus.

This article is sponsored by Alter Domus

With talk of a recession on the horizon, why should LPs back mid-market funds when large caps tend to show lower return dispersion?

Tim Toska, Alter Domus

In the mid-market there’s still a lot of value generation happening. In terms of ultimate returns, yes, dispersion is going to be much higher than for large buyout funds. But in terms of getting out of a recession, backing owner-­operators with the right advisers and experience – managers that have shown their ability to be hands-on and have a track record of improving operations of portfolio companies – is important. If LPs can find and trust those type of managers, and there are plenty out there, then they have an opportunity to get outsized returns.

The latest Private Equity International LP Perspectives study found 23 percent of respondents are over-allocated to private equity for this year. At the same time, many of their favourite managers are back in market. How are LPs responding to this allocation challenge?

As much as LPs feel they’re over-­allocated right now, they are still hungry to participate in the asset class. There’s no intention to dial it back. There has also been a slowdown in exits and distributions, so what we have seen has been investors using the secondaries market as a means of getting liquid­ity to make new investments while others are reducing their exposure to their older vintages. With the growth of the secondary market over the last few years, it has been interesting to see the high volume of transactions.

Are LPs able to command a decent price for those assets?

It really depends on the relative pricing date. Any private asset class is going to be either trailing the public markets or, at a minimum, not be exposed to the volatility. There have certainly been discounts to NAV, but it has been relatively fair and not over-reactionary to, say, the public markets or some of the more general macro fears. There are still plenty of quality assets out there, albeit maybe their time horizon for operational improvements and final exit has been extended.

Is there enough LP capital to meet demand?

As we have already seen, fundraising has slowed down considerably compared with 2021. Managers that have typically held two or three closes within 12 months to meet their target – we may see these extend to 18-24 months. After last year’s record-breaking fundraising, managers were quick to come back to market. It is safe to say that there is clearly a big appetite for private equity across investor bases.

There’s a lot of structural change happening in terms of the US Securities and Exchange Commission rules, especially in North America, around who can participate in private equity. Longer term, retail investing is going to play a big part of meeting the LP demand; it must be in order to achieve the expected growth in private equity. It can’t just be the traditional asset allocators. We’re also just scratching the surface on investment options for 401(k) plans investing into the asset class.

How are mid-market managers looking to stand out in the fundraising market?

Many are looking to specialise and highlight differentiation. We have seen more thorough diligence from LPs who will invest with those firms that have shown time and time again that not only are they just buying in the right market conditions (ie, at a lower multiple and selling at a higher multiple), but are actually improving the EBITDA, operations, cost and revenue figures, as well as increasing brand awareness. That’s happening especially in this mid-market space, where there’s such a dispersion of the size of the firms and where they are in their respective lifecycles.

Which industries are particularly appealing?

I still believe service IT provides a lot of value. During the pandemic we started seeing a bubble in terms of multiples and valuations of so many of these companies that were supporting the tech needed to connect people around the world when we were all working at home. However, that trend has also unlocked all these other tangents, such as cybersecurity, data warehouses and data analytics. I still see plenty of opportunities to invest in the variety of tech innovations and deal volume seems to support it.

The other interesting sector continues to be healthcare. There’s a lot of opportunities in the biotech space. Again, it was great in terms of exits and there might have been some fears around making new deals because of high valuations, but I consistently view it as attractive.

What are some of the pain points mid-market managers face today and how can the right fund administrator help alleviate them?

Data requests across all aspects of an organisation represent a real pain point. This has led to the scope of services becoming broader than five or 10 years ago, when there was very much a focus on day-to-day accounting, capital calls, distributions, maintenance of an investor portal, audit support, financial statements – the foundation of the fund administration world. That’s now morphed into this ability to partner with our clients on more ambitious projects.

It’s not just the back office. Now we’re providing or looking to create new solutions for the middle and front office, too. We have marketing data rooms and digital subscription fulfilments to assist in the marketing and fundraising stage. That’s connected to a customer relationship management piece, which then connects to the investor portal. Then we can connect all the data of the day-to-day accounting at the portfolio companies to the client and investor portals.

We’ve started to develop data analytics solutions for our clients, looking at the market and their portfolio companies and identifying indicators in the macro environment, while enriching the data with their own portfolio company data that might signal an opportunity. We have also developed solutions around ESG reporting, which can be a lot of heavy lifting not only for the manager but for the portfolio company.

How is the average mid-market firm judging a potential fund administrator?

It comes down to three key things. First, the operational expertise of the staff. Second is technology. We like to point to our tech roadmap to show that we recognise the importance technology is playing into all aspects of fund administration. We want to make people more efficient and to be able to give managers data more quickly so they can share it across the firm and with their LPs. The third thing to judge a fund administrator on is the robust level of services offered. Clients don’t want to have a different service provider on each aspect of their firm; they would prefer to have a single administrator and point of contact that understands their ­requirements.