After a year of record returns, LPs expect private equity to become more complicated from an economic and societal perspective, according to a new report.
Coller Capital’s latest semi-annual barometer of the private equity ecosystem suggests that, like it or not, the days when private equity was private – in the stealthy sense – are coming to an end.
“The industry is now simply too big for society to ignore,” wrote Jeremy Coller, the eponymous firm’s chief investment officer, in the report’s release. “The days when private equity flew under the radar have gone.”
LPs are aware of this pressure, as well as the pressure to ferret out returns in a crowded, complicated and evolving field.
As covid is predicted to settle into endemic status during 2022, how will these sentiments feed through to GP actions? Here are the chief insights from the winter report, which captures the views of 102 investors.
The search for returns
Co-investment has been a way for institutional investors to bring down the net cost of alternatives investments and gain access to differentiated dealflow.
The number of LP organisations that have co-investment mandates is “enormous”, said Eric Foran, a partner based in Coller’s New York office. Accordingly, 56 percent of LPs are changing their business practices going forward to make themselves more attractive to GPs as co-investors.
A whopping 90 percent said they were working to increase the internal speed of decision-making. “I’ve certainly seen scenarios where the period that LPs need to react to a potential co-investment is short,” said Foran. “That alone takes a lot of investors off the block in terms of seeing the opportunity or being able to participate in the opportunity.”
Also of note, 22 percent of LPs said they would consider paying economics on co-investments, when usually the co-investment pool for investors is defined by not having economics, according to Foran.
“I would imagine the LPs that are more willing to pay economics are probably more focused on potentially extracting premium deals from sponsors that maybe they’re not invested with already.”
Secondaries: here to stay
This year has undoubtedly been an inflection point for the secondaries market.
Almost all LPs (86 percent) believe that the secondaries market in private equity will grow further in the next three years, while nearly half of investors foresee secondary market expansion in private credit (48 percent), infrastructure (48 percent) and real estate (41 percent).
However, despite the soaring transaction volumes and amount of dry powder, more education is still required in the market at large. While a majority (57 percent) believe the principal effect of the recent rise of continuation vehicles will be to strengthen the overall PE ecosystem, the remaining 43 percent think the proliferation is likely to undermine the 10-year fund model.
This may be a false dichotomy: “I do think [continuation vehicles and the 10-year fund model] can coexist,” said Foran. The ability to extend the period under which a GP can own a portfolio company gives GPs and LPs more optionality around liquidity, as well as the ability to maintain hard-wrought relationships with management teams.
“LPs have had to change their behaviours and mindset when it comes to reacting to this market,” said Foran. “Five or six years ago, LPs were used to making a 10-year commitment and putting it in the drawer. Now with continuation funds, LPs have to make a decision at some point during that holding period.”
Notably, a higher proportion (66 percent of respondents) thought the practice would be positive for the portfolio companies transacted upon.
LPs are aware of the issues in the larger social climate. Fifty-nine percent of respondents, a modest majority, thought societal pressure would ultimately necessitate the private equity industry to self-regulate within the next few years, while 41 percent thought compliance with government regulation would be sufficient.
Further, more than two-thirds of LPs (68 percent) are either already monitoring the social media accounts of individual members of GP teams or are likely to start doing so.
“It is not all that surprising that LPs are doing that in this day and age, especially with diligence being done virtually,” said Foran. “There’s a lot of information out there and available. Private equity is still very much a people business.”
There is still variance across markets with regards to the severity of these pressures. While the majority of European LPs (56 percent) have rejected a fund commitment primarily on the grounds of ESG, just 25 percent and 33 percent of their American and Asian counterparts had done the same.
In contrast, European LPs are much more pessimistic when considering the efficacy of anti-greenwashing regulation in the next three years than their American and Asian counterparts.