GP stakes funds: An acquired taste

Investor appetite for GP stakes funds has expanded rapidly, but some LPs are still treading carefully.

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GP stakes funds are securing investor commitments at a higher volume than at any time in recent years.

According to Private Equity International’s LP Perspectives 2023 Study, 29 percent of LPs have invested in one or more GP stakes funds, up from 24 percent in the 2022 study and almost a third higher than the 20 percent reported in 2021.

While GP stake sales are nothing new, blind-pool funds dedicated to buying up shares in private markets managers have taken off during the last decade, spurring a flurry of GP management company deals and the launch of new entrants pursuing the strategy.

Michael Rees, co-president of Blue Owl Capital and the head of the firm’s GP stakes platform Dyal Capital, told affiliate title Buyouts that the market is growing at roughly 10 percent a year and on track to expand from $530 billion in 2022 to $749 billion by 2025.

Even though Dyal has secured $12.5 billion for its latest GP stakes vehicle, Dyal Capital Partners V, and new entrants including Azimut Alternative Capital Partners, Bonaccord Capital Partners, Hunter Point Capital and RidgeLake Partners have entered the market, the investable universe is growing faster than funds can deploy.

“The fish are reproducing faster than we can pull them out of the pond,” Rees said.

For GPs, the expansion of the stakes funds universe has provided opportunities to sell down shares in their management companies to unwind founder equity positions, facilitate succession or secure capital for investment in building out new strategies on their platforms. For LPs, GP stakes strategies offer exposure to the growth in fee-earning assets under management in the private equity space, which can support a yield strategy. Some deal structures can also offer some governance rights and participation in carry pools.

GP stakes strategies, however, are not for everyone, particularly through a period when private equity fundraising is cooling after reaching record levels in 2021, per PEI data. According to the LP Perspectives 2023 Study, only 7 percent of respondents that have not already invested in GP stakes funds intend or would like to do so in the future, down from 16 percent in the 2022 study. Almost two-thirds of respondents (64 percent) have no plans to invest in GP stakes funds, up from 60 percent in 2022.

One aspect of the strategy that has prompted some LPs to step cautiously is whether the market starts to bump up against a ceiling of investable candidates.

“The basic premise of the fund strategy is around the growth of fee-earning AUM of the underlying GPs and the profitability that goes along with it,” says Jim Strang, previously EMEA chairman at Hamilton Lane and currently the chair of HgCapital Trust and a non-executive director at the Business Growth Fund. “That is very much dependent on size of funds, so for smaller funds below the billion-dollar/pound threshold it is going to be interesting to see how the maths works, because you may be banking on quite a lot of growth to drive returns in these smaller funds.”

“How capital will flow back to investors from these structures is still somewhat unclear”

Jim Strang
HgCapital Trust

On the other hand, it can also be argued that the pool of available investment is just defined by the number of managers of scale in the market. By looking at the addressable market by overall enterprise value, re-ups can be considered in addition to new investment, expanding the investable universe.

The LP Perspectives 2023 Study also reflects a degree of concern in the LP base about how funds will eventually exit GP stakes positions and the potential for conflicts of interest.
More than half of respondents are a little concerned with a lack of predictable exits, with just under a quarter very concerned, although a further 24 percent are not at all concerned.

“How capital will flow back to investors from these structures is still somewhat unclear,” says Strang. “It comes down to answering the question about what you are underwriting to and what your route to liquidity is.”

On the conflicts of interest point, 52 percent are somewhat concerned, a fifth are very concerned and 28 percent are not concerned at all.

“Some LPs have a harder time with GP stakes than others, because the model is built around fee-earning AUM growth rather than the performance of the actual funds that investors back,” Strang says. “It does depend on the nature of the LP, and different types of LPs will view it slightly differently.”