‘Flight to familiarity’ – the latest risk for LPs in private equity

Private equity investors favouring familiarity in times of crisis could miss out on opportunities to deploy capital, a panel has heard.

Private equity investors need to be careful of a “flight to familiarity” risk in the near to medium term as travel restrictions make it harder to commit to new managers, a panel has heard.

Speaking at the EisnerAmper Virtual Investment Summit last Thursday, Jennifer Choi, managing director of industry affairs for the Institutional Limited Partners Association, noted that LPs are primarily focused on re-ups with managers they already knew pre-crisis and could be in danger of missing opportunities resulting from the pandemic.

Eisner Amper LP Panel - Jennifer Choi
Jennifer Choi: don’t waste a good crisis

“For the most part, LPs are not yet making new commitments to managers that are new to them, where they haven’t had the benefit of an in-person meeting in the past. And so, it does beg the question: ‘What kind of a deal are LPs getting in this environment, where there is a flight to the familiar, whereas we saw a flight to quality in the global financial crisis?’” Choi said.

“I don’t think we’ve yet seen materialised the kind of gains in the quality of alignment of interests between GPs and LPs that we would’ve expected in a more of a supply demand imbalance … in a market where LPs might’ve gained a bit of an advantage in negotiations – that’s not happening yet.”

As LPs are keen to put money to work, it should be top of mind not to waste a good crisis and to take advantage of opportunities to deploy capital, she added.

In August, tech giant Silver Lake gathered $18.28 billion for Silver Lake Partners VI, which is yet to hold a final close. Other mega-funds that have benefited from LPs flight to quality include Ardian, which raised €19 billion for its latest secondaries programme, and CVC Capital Partners, which hauled in €22 billion for its eighth flagship fund, according to PEI data.

In addition to what could be flight to familiarity risk in the medium term, the industry should also think about LPs as counterparties and the counterparty risk associated with the type of LP, said Wes Bradle, a senior portfolio manager at Florida State Board of Administration, on the panel.

“High-net-worth investors, for example, tend to lever up in really good times but when markets turn, they face margin calls and liquidity evaporates, which can lead to capital call defaults.”

Bradle added that hospital systems and healthcare endowments could face lower revenues should there be a second wave of the pandemic. Similarly, a drop in charitable giving will hurt university endowments, and lower tax revenues will impact state pensions and their future commitment decisions, he said.

“That’s why it’s important for PE funds to have high-quality LPs and that they diversify their LP base by type of LPs,” Bradle said.