Coller Capital’s latest barometer in five charts

Preparation for a downturn, fund terms, private equity's 'licence to operate', climate change and retail investors were standout topics in the firm's latest investor survey.

Limited partners are anticipating needing to make modifications to their private equity portfolio to prepare for an impending downturn, according to Coller Capital‘s Global Private Equity Barometer for winter 2019-2020 published Monday.

The 113 private equity investors surveyed also foresee a two-tiered GP market emerging in the next economic downturn.

Here are five key takeaways from the survey, which reveals LPs’ views and plans for their private equity portfolios:

1. Preparation is needed for an impending downturn

The vast majority – 80 percent – of limited partners in North America say their portfolios need modifications to prepare for the next downturn, while those in Europe appear to be more prepared.

“It’s interesting to see such a large percentage of LPs stating that further portfolio modifications are required,” Coller Capital partner Eric Foran told Private Equity International. “LPs widely acknowledge the macro environment as a risk to PE returns, and many have been active in using the secondary market for portfolio management purposes.”

Modifications could include rebalancing the portfolio by geography or strategy.

When it comes to macro risks, 92 percent of LPs say high asset prices are a significant risk to private equity returns in the next few years, while 90 percent are concerned about the macroeconomic environment.

2. Terms could turn in LPs’ favour

Ninety-three percent of LPs surveyed expect a “significant divergence” in GPs’ private equity returns in the next economic downturn due to differences in the quality of GPs’ strategies and teams; just 7 percent indicated the industry has changed sufficiently since the global financial crisis. In addition, around two-thirds expect to see a further divergence in individual GPs’ fund terms and conditions in the next five years.

“The quality difference between GPs is likely to be a factor – especially in relation to less active managers who may not be able to navigate their portfolios through a market downturn,” Foran said.

This will lead to management fees coming under pressure. However, almost 40 percent of investors also anticipate a decrease in hurdle rates, likely reflecting the increase in instances of top quality managers pushing for lower hurdle rates on sought-after funds.

3. LPs are seeking a better defence of PE’s licence to operate

Unsurprisingly given current political rhetoric in the US, 69 percent of North American LPs believe political and media criticism of private equity have grown louder in recent times, almost double the 36 percent of European LPs. Limited partners are clearly concerned about public perception: 76 percent say more needs to be done by the private equity and venture capital industry associations to explain the industry and to defend its licence to operate.

4. Climate change is becoming a factor

A recent market outlook report from Cambridge Associates urged investors to invest in climate change solutions to build portfolio resilience for the future, particularly advocating for building exposure to climate mitigation and adaptation solutions through venture capital and growth equity opportunities.

Coller’s survey found LPs’ likelihood to modify their investment strategy in response to climate change was dependent on where they’re based, with European and Asian LPs most likely to make changes in the next five years.

“It’s fair to say that the North American LPs do lag the rest of the world in how they’re thinking about ESG matters,” Foran said.

Investors appear just as likely to invest behind climate-friendly products and renewable energy as they are to reduce investment in oil and gas.

5. LPs discourage retail investors

Amid a push from some corners of the asset class to bring more retail money into private equity, LPs are not on board with the idea. More than half of North American and Asia-Pacific LPs – 57 percent and 52 percent, respectively – believe that significantly more retail money will be invested in private equity in the next five years, yet only 27 percent think improved access to PE for the general public would be a good thing. Almost three-quarters say private equity is not suitable for unsophisticated investors.

– Isobel Markham and Preeti Singh contributed to this report.