LPs focus on fees and co-investments

Limited partners that made significant co-investments in 2011 are finding a healthy amount of co-investment opportunities in 2012.

Limited partners are increasingly targeting better returns by negotiating fee breaks and committing to funds with significant co-investment offerings.

That’s according to a panel of LPs who spoke at the Dow Jones Private Equity Analyst conference in New York Thursday.

“One thing that we do pay a lot of attention to are the monitoring fees,” said Mina Pacheco Nazemi, a director in Credit Suisse’s private equity fund of funds business. “We actually model out how much the GP will be taking out in different types of monitoring fees throughout the [fund] life. We track that because at the end of the day we want to have the most alignment with the sponsor.”

LPs that don’t have enough capital to set up separately managed accounts are still negotiating preferential terms with GPs, according to managing director of BAML Capital Access Funds Craig Fowler.

“[LPs] are looking to invest large amounts in single funds to negotiate better terms,” he said. “They’ll continue to look for a way to enhance returns through fees, better terms and also [by] looking at tweaking strategies, whether that be terms or co-investments.”

While funds offering co-investments have been popular among LPs recently, many LPs only co-invest with GPs to which they’ve made primary commitments, and some require extensive vetting of co-investment opportunities offered by existing managers.

“It’s not just the GP that we’re looking at but actually the specific partner on the deal,” said Jeffrey Reals, managing director of Performance Equity Management. “If this is a strategy that he or she has employed before that garnered prior success that we can look at, that gives us a whole lot of comfort.”

In 2011, Performance Equity Management made 11 co-investments, Reals said, worth a combined $220 million. This year, the firm has participated in five co-invesments.

“I think [co-investment] deal flow has been reasonably good this year,” said John Wolak, managing director of Morgan Stanley Alternative Investment Partners. Morgan Stanley has co-invested four times so far in 2012, and in 2011 made 10 co-investments totaling about $250 million.

“One area that we really like, and that’s a big part of our primary business is special situations funds,” Wolak said.

While special situations and distressed strategies have been increasingly popular with LPs, Hall Capital, an advisor to families, endowments and foundations, will only invest with distressed managers that also invest in other strategies.

“Every single one of the distressed managers that we have has a proven track record of making equally as interesting returns in non-distressed investments as in their distressed investments,” said head of the private equity group Jessica Reed Saouaf.

“Being with managers that can do a subset of distressed opportunities but not be overly dependent on that….Those kinds of versions of distressed are really what we’re most focused on in our private equity portfolio.”

Like many LPs, Hall Capital has been actively reducing its GP relationships for a number of years.

“In 2007 we had about 65 active manager relationships. Now we’re down to between 40 and 45, and we’ve added managers in venture and emerging markets, so there is pruning,” she said.

The firm reduces its GP relationships through “natural attrition” rather than by accessing the secondary market, and makes between 8 and 10 re-up commitments per year, Saouaf said.

“In some cases, especially in the mid-market or large buyout for example, we’re not re-upping with managers that have done a really solid job. Unless we can look at the future and say this is a clearly compelling differentiated strategy with identifiable value add over time – and importantly an organization that is focused on driving returns for LPs – then we’re willing to pass.”