GAIF Japan: Flight to quality shifts LP-GP dynamic

Getting access to quality funds has become a main issue for LPs, according to panelists at PEI's Japan forum.

The flight to quality in fundraising has brought the issue of allocation to the forefront and fee discounts to the background, delegates heard at PEI’s Global Alternative Investment Forum: Japan 2014 in Tokyo.

“What we see is see is a feast or famine situation [among managers raising funds],” said Thomas Kubr, executive chairman at Capital Dynamics, speaking on a panel. “The globe is full of capital for the right managers.” 

Several other factors are complicating the situation, including a general LP under-allocation to private equity as distributions on a global basis increase.

“This is the first time in many years we’ve seen net cash out, meaning cash back to LPs. So they want to reallocate and everyone is chasing what they perceive are the good managers,” he said, speaking to an audience of mainly Japanese LPs.

Kubr added that LP-GP power dynamics have shifted in the current environment, and LPs can no longer flex muscle on fee reduction issues as they could a few years ago.

Investors that want allocation to big funds perceived as high quality will have to take the fees that are asked. “If they don’t want the [offered terms], a lot of others are waiting who will take it.”

Jonathan Shofet, managing director of Neuberger Berman, said that his firm has typically been highly selective when evaluating fund managers. However, in the current fundraising environment, it’s not only selectivity, but access.

“From a process perspective, you used to have maybe a year’s time to evaluate managers before the final close. Today we have to be well ahead of fundraising. Six months or even a year before the fund is being raised, we’re approaching the managers important to us to make sure we can get an allocation. It’s a big shift in the way business is being conducted today.”

Given the fundraising climate and the optimism surrounding Japan’s economic stimulus, Atsushi Mizumura, general manger in the investment department at the Development Bank of Japan, said that DBJ will remain with a consistent investment strategy. 

He said the most important factor in evaluating a fund is the key man. 

“Therefore when doing due diligence, meeting the key person is the highlight for us. By doing so, we can learn his philosophy and his team’s capability. [Returns] are very important to us, but the most important factor is what the key person is thinking.”

Mark Shipman, partner, Clifford Chance, who moderated the panel, added that the key person clause has lately been getting more emphasis than other terms in LP partnership agreements.

Some of the panelists acknowledged US capital allocations are increasing while emerging market allocations are decreasing. But they agreed that emerging markets remain a critical part of an LP’s portfolio.

Maarten Vervoort, managing director, AlpInvest Partners, said very attractive returns form emerging markets during 2000-2005 sparked a huge flow of capital into emerging markets, which many markets were unable to absorb in the short term due to the lack of a large, mature private equity industry.

“So a lot of second and third tier managers were funded and a bit of a bubble occurred. That doesn’t alter the fact that those markets are attractive — it says more about the behavior of investors.”