Friday Letter: Unlimited burden

Delegates at PEI’s Active Portfolio Management Forum in New York this week made clear that GPs must work much harder to prove their worth to LPs already burdened with huge unfunded commitments.

Yesterday, PEO broke the news that Pantheon Ventures had closed its fourth global secondaries fund with $3 billion in commitments, while earlier this week we were the first to reveal StepStone Group’s push into the secondaries market. But these firms represent just two of the many private equity players readying for a surge in secondaries dealflow.

Last month, PEI provided an in-depth look at how the secondaries market has come roaring back to life in 2010, driven largely by bank-initiated transactions as financial institutions increasingly deem their private equity holdings (or indeed, their in-house private equity units) non-core. But this week we were reminded that the banks certainly aren’t the only limited partners looking for liquidity.

Delegates at PEI’s Active Portfolio Management Forum in New York stressed the importance of the secondaries market to allow for the rebalancing of LP portfolios. Over-allocation has been, and remains, one of the main motivations behind the sale of LPs’ private equity stakes. As is the need to pare down relationships. It’s become somewhat common to see portfolios with 100 to 150 managers, said one secondaries market insider on the conference’s sidelines. “There’s no way to really manage that number of relationships,” the professional said.

But what is more pronounced today than ever before, delegates and speakers repeatedly noted, is the vast unfunded commitment burden LPs carry. Cambridge Associates has estimated a capital overhang in the private equity industry of about $425 billion, an excess that will take years to burn through. This of course means a slew of unfunded commitments hanging over LPs, which are already wary of liquidity issues given the portfolio problems experienced during and post-financial crisis.

“Perhaps there is no liquidity issue today, but it’s perceived there will be one in the future,” said a secondaries investor who noted that many LPs increasingly wish to “get out from under the unfunded burden”.

That is particularly true if an LP has lost confidence in a GP based on recent investments performing poorly. And, delegates noted, the unfunded burden becomes more exasperating when GPs which have not distributed very much, and still have capital to invest from prior funds, come back asking for re-ups.

Speakers and delegates at the forum emphasised that LPs were taking very proactive steps, constantly reworking their portfolios to get the most out of their commitments to the asset class. While this is indeed good news for the many secondaries-focused funds and advisors, it is also a signal to primary fund managers that they will have to work harder, and probably with less capital, to keep LPs happy.

One LP at the forum was asked when the primary fundraising market might get back to normal. They responded tellingly that if normal meant a number that would “make people in this room happy … I don’t think we’ll get back to that until 2014”.