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Eight in 10 LPs responding to Private Equity International’s LP Perspectives 2021 Study say they plan to either maintain or increase their number of GP relationships over the next 12 months. However, fresh waves of covid-19 restrictions may make this hard to achieve and niche players, particularly new managers, may lose out while mega-franchises and brand names benefit.
“Those LPs that have been on the brink of moving away from the large, diversified players are likely to retrench and essentially household names will raise an even greater proportion of the total pie than before,” says James Coleman, founder of Quest Fund Placement.
“LPs will further consolidate their capital and smaller managers will struggle on a comparative basis.”
While 38 percent of investors say they are just as likely to invest in first-time managers than in the previous year, and 13 percent are more likely to do so, there is no denying that emerging manager fundraising has been challenging in 2020. There may be further tough times ahead. Indeed, 20 percent of LPs are less likely to back first-time managers over the next 12 months.
“On a relative basis, appetite for emerging managers has been small for some time and disproportionately focused on spin-out groups where an individual team already has a track record and established relationships with LPs,” says Coleman. “Physical barriers to meetings either with GPs or with other market counterparties as part of the due diligence exercise has further reduced the ability to assess first-time teams.”
Merrick McKay, head of European private equity at Aberdeen Standard Investments, agrees that the practical obstacles to first-time fundraising are significant. “A lot of investors have been relying on muscle memory when it comes to reupping in existing funds. For first-time managers, the lack of opportunity to meet with prospective LPs has been challenging.”
However, McKay adds that Aberdeen has invested in a manager that none of the team had met personally for the first time ever this year. “It is possible,” he says. “But let’s not pretend it is the optimal situation. It is a tough proposition and first-time funds will take longer to get there.”
Yet Gabrielle Joseph, head of due diligence and client development at Rede Partners, believes investors are starting to open up to the possibility of truly remote fund commitments. “We know there are challenges in closing blind pools of capital at the moment, where investors have never met the managers in person, which is why some emerging managers are having success in getting their initial deals backed by co-investment instead,” Joseph says. “But we are starting to see a growing number of LPs that are willing to consider making new GP relationships without prior in-person interactions, although of course, the bar is very high.”
Meanwhile, around a third of investors say they have either already invested in a GP stakes fund or would like to do so. Aberdeen has its own vehicle specialising in just this trend. “We see fewer opportunities in Europe, because so many European funds were established as partnerships from the get-go, and so already have mechanisms in place for transferring value. But, in the US, there are many firms that were set up by just one or two people,” says McKay. “We see that as an exciting opportunity.”
However, the sale of GP stakes can be problematic for some LPs, who question whether selling an interest in the firm impacts GP motivations and LP-GP alignment. For example, GPs may be rewarded for results that do not necessarily benefit the underlying investor, such as launching ancillary products to drive new fee streams, says Jennifer Choi, managing director of industry affairs at the Institutional Limited Partners Association.
“LPs have also lamented inconsistencies in notifications to LPs when a sale is taking place, or disclosures around who has an economic interest in the GP,” adds Choi. “For some LPs, this has become a feature of their diligence, where they may have a slight preference for GPs that have not yet sold a piece of the firm to a third party.”