The LP of the future will look a lot more like a GP. Instead of relying on the discretion of fund managers in blind-pool vehicles, the LP will have much more control over its investment exposure – and much lower fees – thanks to an increased proportion of co-investments, direct investments and customised mandates.
The trend for investing outside the confines of a commingled fund has taken hold since the financial crisis. According to Coller Capital’s 2017 Global Private Equity Barometer, the percentage of LPs co-investing alongside general partners shot up from 26 percent in summer 2006 to 55 percent in the winter of 2017-18. The proportion making direct investments jumped from 17 percent to 31 percent over the same period.
The benefits to LPs suggest the enthusiasm for these opportunities will remain. Dave Smith, co-head of co-investments at Capital Dynamics, believes they will account for a “substantially increased proportion, driven by a combination of co-investment having come of age and limited partners’ demands for a lower cost of access to an expensive asset class”.
Innovation should iron out some creases. In the traditional fund model, LPs are often unable to respond quickly enough to GPs’ calls for co-investment capital. To address this, we are likely to see more investment company-type structures, perhaps with LPs on their board, which can help reduce the pressure, according to Shawn D’Aguiar and Ajay Pathak, fund formation partners at law firm Goodwin.
It’s also possible that growing numbers of LPs will enter funds primarily with the aim of doing direct or co-investing. Arrangements with the GP would be tailored – lower fees for investment recommendations, cashflow projections and monitoring, higher fees for anything more specialised.
While the move towards acquiring minority stakes in GPs has increased in recent years, few PEI spoke to expect it to become widespread. Some sounded a hint of caution around the risk of conflicts of interest. Still, around a third of LPs already are, or are considering, making such investments, according to Coller Capital data.