GP interests: Niche work if you can get it

Funds that buy stakes in private equity firms are hot property; but growth in that segment is naturally constrained.

GP stake funds have a lot of fans, but they will not be for everyone.

Dyal Capital Partners, Neuberger Berman’s dedicated fund of firms unit, is expected to close Fund IV on more than $7 billion this quarter, PEI reported on Wednesday. The firm had initially sought around $6 billion but upped this after completing six of its 12 targeted deals in 2018 alone.

Investor demand for such vehicles is “disproportionately large” compared with other strategies, Coller Capital’s Remco Haaxman told PEI in June. A survey of 112 limited partners undertaken by the secondaries firm found 17 percent had already invested in GP-interest vehicles and a further 19 percent will consider doing so in future.

The appeal is clear: a heady fundraising environment has seen private equity firms enjoy rampant AUM growth through new funds, strategies and platforms. With greater AUM comes greater management fees; Dyal’s investments typically entitle it to 20 percent of management fee income and 10 percent of carried interest.

An attractive risk-return profile was cited by 58 percent of the 42 limited partners surveyed in Hamilton Lane’s Private Markets Survey 2018-19, representing $5.5 trillion of AUM, as the primary reason for backing GP stake funds.

Alaska Permanent Fund Corporation, the $65 billion sovereign wealth fund, is certainly a fan. It has taken stakes in Vista Equity Partners, EnCap Investments and Starwood Capital Group alongside Dyal Capital Partners (as well as backing Dyal’s funds).

Yet the strategy has its limitations. Dyal, for instance, targets managers that have cornered their market – think Silver Lake for technology or EnCap for energy-focused growth capital – and there are only so many GPs that meet this criterion.

Proponents of the sector would argue that the evolution of firms like EQT (which is currently reviewing options for outside investment) and BC Partners into multi-asset players is evidence of a constantly evolving opportunity set.

But not every GP is clamouring for another shareholder. Of the 22 GPs Hamilton Lane surveyed, “most” have met with a firm that proposed taking a stake in their business. Although the survey did not outline how many declined, the main reasons for doing so were a lack of clear value-add and having no use for the capital.

Investor appetite – while buoyant enough to lift Dyal to $7 billion – is not limitless. Carlyle Group’s AlpInvest recently cancelled a fundraising process for acquiring GP stakes amid a string of departures from its “partnership” fund team, PEI reported this month. The Amsterdam-headquartered firm no longer has plans to raise a dedicated pool of capital for the strategy.

One potential deterrent may be the lack of an obvious exit route. Evergreen fund structures such as Dyal’s don’t plan for an exit; investments are expected to go on indefinitely. LPs requiring liquidity would need to explore the secondaries market.

A senior executive at a European pension manager with more than €100 billion of AUM told PEI his firm wouldn’t be able to consider permanent capital funds as many of their client mandates don’t allow for evergreen investments.

Seventy percent of LPs in the Hamilton Lane report have not invested in a GP stake fund. Of these, 40 percent have not done so because they dislike the strategy and one-third cited concerns over liquidity. Only 13 percent hadn’t been given the opportunity.

The case for GP stakes is certainly compelling for those who prefer healthy cashflow yield with no time constraints, but they are likely to remain an acquired taste.

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