HarbourVest: Private equity firms are taking on more risk

Greg Stento, a managing director at HarbourVest Partners, worries the lessons learned from prior downturns are fading.

Greg Stento

In an environment of high valuations and riskier investments in the private equity market, Greg Stento, a managing director at HarbourVest Partners, believes conservative assumptions and creative offerings will help prepare for a potential downturn.

What surprised you most in 2017?

During 2017 there was a good deal of political uncertainty. Performance across private markets continued to be strong, even with these headwinds, which really speaks to the strength of the economies, the strength of the asset class and of the managers with whom we are investing. Despite the uncertainty on the horizon the asset class has certainly performed very well.

How is HarbourVest addressing such concerns at this point in the cycle?

More in the second half of the year, it seems that lessons learned from the prior downturns are becoming more distant. Whenever you get deeper into a strong economic cycle, those lessons learned tend to fade. Some private equity professionals with about 10 years of experience who have not seen a down market before are starting to get to mid- and high-level management. In the last quarter or so we’ve started seeing some investments getting done that are probably further out on the risk curve than what we would typically see.

We’ve been modelling in our return analysis multiple compression at the potential exit of our investments at the 10-year historical medians. We’ve been trying to be very conservative in terms of our assumptions. We’ve also been modelling recession cases in every deal to ensure that we understand the sensitivities around these investments and whether companies can withstand potential shocks over the next five years.

Some private equity professionals with about 10 years of experience who have not seen a down market before are starting to get to mid- and high-level management

You also have to be creative to find compelling deals. We had to do that certainly in 2017. In the co-investment area, there are a lot of investors out there with capital who want to make co-investments. We position ourselves as a solutions providers to general partners. We have the flexibility to participate up and down the capital structure whether it is equity or debt. We can also work with GPs who later on want to syndicate co-investments, helping to warehouse some of that investment for them. That’s something that GPs have been very interested in 2017.

Co-investment as a service to LPs has also really emerged. LPs may have relationships with managers who are offering co-investments to them but they are just not staffed and equipped to be able to process those co-investments themselves. We are actually doing that as part of our overall relationship with them.

What do you expect in 2018?

We’ve had good liquidity and distributions in 2017. Many investors are having difficulties keeping up with their private market allocations due to the fact that they’ve been getting a lot of capital back. In addition, the very buoyant public markets are increasing investors’ denominator so they can’t maintain their allocation percentage to the private markets asset class. As a result, we’ll continue to see investors needing to deploy capital into comingled funds and into customised solutions during 2018.

HarbourVest manages $45 billion in assets across primary investments, secondaries and co-investments. Separately managed accounts represent about one third of the capital raised by the firm in the last three years.