LPs: Allocations rise but causes for concern remain

A significant proportion of LPs plan to increase allocations to private equity, according to the latest Coller Capital Barometer, which also found LPs are increasingly concerned about the proliferation of special accounts.

One third of European LPs are planning to increase their PE allocation, while just 5 percent plan to reduce it, according to Coller Capital's Global Private Equity Barometer for summer 2012. Amongst Asia-Pacific LPs, 20 percent plan to increase their allocation, while the same proportion plan to decrease it. In North America, 13 percent plan to increase, while 10 percent plan to decrease their exposure to the asset class.

Overall, 42 percent of investors expect private equity to increase its share of balanced investment portfolios over the next three to five years, while 19 percent expect it to decrease.

Most invest in private equity in a bid to boost overall returns, according to the survey, although some also cited managing risk through increased diversification and reduced volatility as reasons to invest in the asset class.

Cause for concern

The manner in which some investors are accessing private equity funds is causing concern amongst LPs, however.
One in eight LPs now have a special or separate account with a GP, according to the survey. Amongst large investors (those with total assets under management of $20 billion or more), the proportion rises to one in four.

But half the LPs surveyed said the growing number of special accounts was a negative development for the asset class as they create the potential for conflicts of interest between GPs and their LPs.

The proportion of LPs making direct investments – either on a standalone or co-investment basis – in companies has also risen substantially over the last six years, from 35 percent in 2006 to 66 percent in this year’s survey. That is likely to rise still further, with 42 percent of respondents saying they would increase their level of direct investment over the next three years.

The rise of the secondary market

The growth of the secondaries market is also set to continue unabated, according to survey. In the next two to three years, more LPs plan to use the secondaries market, either as buyers or sellers, than have used it in its entire history.

If private equity is to deliver its full potential for society – in terms of prosperity, jobs and competitiveness – investors will have to make their voices heard

Jeremy Coller, Coller Capital

LPs are also looking at sub-segments of the asset class for outsized returns. Distressed debt funds, for example, are seen as a strong proposition. Three fifths of LPs expect such funds to deliver returns in the 11 to 15 percent range over the next three to five years, with 89 percent expecting them to achieve at least 11 percent or more.

Almost two thirds of North American and Asia-Pacific LPs now invested in distressed debt funds, while 38 percent of European investors did so. The proportion of North American and European LPs investing in such funds has remain largely unchanged since 2008, the survey found, while Asia-Pacific investors have substantially increased exposure.

Poor perception: LPs have a role to play

The asset class has a significant perception issue, however, according to the survey. Just under half of private equity LPs think the industry’s reputation is bad, with the same proportion thinking it is neutral. Although 68 percent of North American LPs and 62 percent of European investors thought the industry’s perception was worse than it deserves, the figures imply 32 percent and 38 percent respectively – over a third in each case – thought it’s bad reputation was deserved.

Interestingly, two thirds of respondents said that LPs themselves should speak out more in favour of the industry, through bodies like ILPA if necessary.

Commenting on the findings, Coller’s chief investment officer Jeremy Coller said: “The early history of private equity was driven very much by GPs, but it’s clear that the challenges the industry faces today are as much issues for LPs as GPs. The risks to private equity’s reputation; the rapid growth in special accounts; the regulatory and tax environments for European venture; these are all issues where LPs have a uniquely influential or decisive voice. If private equity is to deliver its full potential for society – in terms of prosperity, jobs and competitiveness – investors will have to make their voices heard.”