LPs pull back from first-time funds

A liquidity squeeze and ever-larger fundraises from established rivals have created a difficult environment for emerging managers, but optimism remains.

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LPs have remained reticent about investing in first-time funds over the last year, as increasingly challenging market conditions and a lack of liquidity dampen enthusiasm for emerging managers.

More than a quarter of investors (26 percent) are less likely to invest in first-time managers in the next 12 months, according to Private Equity International’s LP Perspectives 2023 Study. This is up from 15 percent in last year’s survey and 20 percent in the 2021 study, which captured investor sentiment following the first year of the covid pandemic.

Rishi Chhabria, partner and head of sales in North America at Campbell Lutyens, says LP concerns towards investing in emerging managers include a severe liquidity squeeze caused by a slowdown in M&A activity, as well as the increasing speed with which larger managers are growing and coming back to market – and with ever-bigger funds. This, Chhabria says, “further squeezes institutions as their capital is going to a more concentrated book of managers and limiting their ability to back new groups”.

Indeed, 16 percent of LPs are planning on reducing their overall number of GP relationships over the next 12 months – the highest proportion in the last five years.

Spin-outs still shine

Appetite remains for new managers with a track record and tried-and-tested working relationships, writes Amy Carroll

The combination of coherent track record and cohesive team that is afforded by a whole team spin-out from an established firm makes this one of the easiest forms of emerging manager for investors to get their heads around.

Almost 80 percent of LP respondents to affiliate title Buyout’s Emerging Manager Survey 2022 say they are very likely or likely to back a team that has emerged from a larger sponsor, making spin-outs the most popular type of emerging manager. Investors are markedly more cautious, however, when it comes to individual-led franchises, ex-family offices and teams without a private equity background.

Carolina Espinal, a managing director at HarbourVest, told Buyouts: “When it comes to de-risking an emerging manager proposition, there are clear benefits to backing individuals who have previously worked together and that have a strategy in line with their prior activities.”

Scott Reed, co-head of US private equity at abrdn, agrees: “Successful emerging managers tend to have the cleanest stories. They are often teams that have spun out from credible and well-known firms, with a demonstrable history of working together. When people come together from different houses, it is harder to determine whether they will work together well. Those fundraisings are more likely to struggle.”

Feeling the squeeze

With larger GPs continuing to attract the lion’s share of LP commitments, there are fewer opportunities for emerging managers trying to lure away LPs’ already limited capital. This is being exacerbated by prolonged fundraising processes.

Chhabria says: “Many managers have had protracted fundraises that will not be completed in 2022. One of our institutional investors, for example, told me that 75 percent of their entire private equity book was back in market in 2022. That trend is going to push into 2023, and that’s going to further squeeze investors’ general ability to back managers [in general] next year, not just first-time funds, as [LPs] continue to face this effective glut of re-ups that they have to focus on.

“I’m not surprised to see folks are becoming less likely to invest in first-time funds. It’s not because of a lack of interest, but instead because of a lack of liquidity”

Rishi Chhabria
Campbell Lutyens

“If you’re considering all of these points, I’m not surprised to see folks are becoming less likely to invest in first-time funds. It’s not because of a lack of interest, but instead because of a lack of liquidity.”

According to a survey of LPs and emerging managers conducted by affiliate title Buyouts in partnership with Gen II Fund Services and published in October, nearly two-thirds of GP respondents either agree or strongly agree that investors are hesitant about backing emerging managers; only 15 percent disagree.

“Appetite for emerging managers is often procyclical,” Scott Reed, co-head of US private equity at abrdn, told Buyouts. “When the economy is stable and distributions are strong, LPs are more willing to step out on the risk spectrum and commit capital to newer firms. But history shows us that when markets become more volatile and distributions dry up, a lot of LPs focus their capital on tried-and-true managers, and appetite for emerging managers wanes. That is what we are seeing today.”

In such a market, new managers will need to ensure their offering is differentiated enough to stand out from both their peers and more established GPs.


LPs that are more likely to invest in first-time managers over the next 12 months

“LPs are often so tied up with re-ups that they don’t have the bandwidth to review new relationships,” Paul Newsome, private equity partner and head of portfolio management at Unigestion, told Buyouts. “The biggest challenge that emerging managers face is cutting through that noise to get in front of potential investors.”

However, that’s not to say the picture is completely bleak for emerging managers going into 2023. A slightly higher proportion of respondents to the LP Perspectives 2023 Study say they are more likely to invest with first-time managers this year compared with last year, up from 11 percent to 13 percent, while a further third say they are just as likely do so.