LPs want to make dollar pledges to Euro funds

Europe tops the list of issues LPs are thinking about this year, along with the growing threat of ‘zombie funds’ and reputational risk brought on by the US Republican primary election.

As if fundraising isn’t hard enough: US limited partners have begun asking European managers to create parallel funds so they can make US dollar commitments, avoiding currency risks with the Euro.

That’s according to a panel of LPs who spoke at Dow Jones Private Equity Analyst conference in New York Wednesday. LPs have even gone so far as to reject making commitments to Euro-based funds when managers decline to provide parallel dollar-based funds, according to panelists.

“When LPs ask for dollar sleeves to the fund, in reality they’re passing on currency risk to the manager,” said Luca Salvato, partner with Coller Capital.

LPs want to make commitments with return expectations in their own currencies, according to Avneet Kochar, director of alternative investments with AT&T Investment Management Corporation.

Europe is one of the major concerns of LPs this year, as the continent works to quell a sovereign debt crisis that has raged through the union since last year. The challenges in Europe have caused turbulence throughout the global economy, and uncertainty in the mind of investors.

When LPs ask for dollar sleeves to the fund, in reality they're passing on currency risk to the manager.

Luca Salvato

“Europe is at the forefront,” Salvato said. “People are already asking questions and it’s already affecting people in terms of how they invest.”

While Europe is full of dangers, it’s also full of “opportunities”, said Benoit Verbrugghe, senior managing director at AXA Private Equity. “It’s one of the biggest issues for LPs,” he said. One of the main opportunities has sprung from countries and corporations shedding assets cheaply.

Europe was just one of numerous LP concerns the panel discussed at the conference. Another major concern among LPs – which will continue to plague them this year — has been fund managers with no hope of producing returns or raising future funds, known as “zombie funds”.

“You keep getting fund extension requests and you have to deal with it. If you don’t extend the fund, the GP is going out of business … who will manage the assets?” Kochar said, explaining that “we’ve been dealing with it, and there’s probably more to come”.

An LP’s best defence against a zombie fund is healthy communication with other LPs, the panelists said. However, that is easier said than done.

“There are enough levers there if you work with fellow investors, you can get some progress on the message around what’s the prudent, practical thing to do,” said David York, managing director at Top Tier Capital Partners.

LPs, though, “don’t speak enough together”, according to Verbrugghe, though that has slowly been changing as investors realise the benefits of concerted action.

Reputational risk is another worry as Republican Mitt Romney, who is vying for his party’s nomination to take on President Barack Obama, faces intense criticism over his tenure as head of Bain Capital. Private equity itself has faced intense public scrutiny and will likely remain in the spotlight if Romney wins the nomination.

“The place we’ve heard rumblings is the trustee level of public pension funds,” York said. Illinois state politicians, for example, have formed a committee to examine the investment strategy of the state pension systems to determine if they are taking on too much risk through exposure to alternative investments, including private equity.

However, some believe the negative media attention will blow over with time. “The private equity markets will continue to move forward,” Salvato said. “I think it will wash over.”