LP, WHERE ART THOU?(4)

The controversy engulfing private equity continues unabated, both in Europe and elsewhere. Amid unprecedented scrutiny in the media, the world's most active sponsors are being accused of a multitude of sins – quick-flipping, overgearing, asset-stripping, obsessive secrecy and plain old-fashioned greed to name but the most common charges.

A reminder that private equity's public relations battle may have only just started came last December, when Germany's influential news magazine Der Spiegel ran a fiercely critical cover story on the industry (“The big sell out”, 18 December 2006).

As part of their research, the magazine's journalists interviewed Thomas Krenz, head of Germany at Permira. Judging from the article, however, Krenz's arguments for the merits of private equity activity in the German economy fell on deaf ears. Ignoring the firm's 20-year track record as a business owner in the country, Der Spiegel singled out Permira's management of Cognis, the chemicals carve-out acquired in 2001 alongside Goldman Sachs Capital Partners and twice recapitalised since – and delivered a devastating diagnosis of the company's financial health after five years of “plundering” by the two sponsors.

Unsurprisingly given such experiences, general partners often complain that in the court of public opinion, fair hearings are proving elusive at present. A growing band of senior private equity people, however reluctantly and in no small part driven by a growing fear of hostile regulatory intervention, are now attempting to help improve the image of their industry by taking a more public stance. In addition, European industry associations including the EVCA in Brussels and the BVCA in London have stepped up their efforts to disseminate evidence of the micro- and macro-economic benefits of private equity. In the US, the Private Equity Council has been set up to perform the same task (see pages 28 and 64).

Given current sentiment towards the industry, however, it is doubtful that general partners and the lobbying groups can stem the tide of scepticism all by themselves. Hardened opponents will dismiss the industry's arguments as ultimately self-serving.

This is why some GPs argue that now would be a good time for another type of market participant to enter the debate – the limited partners in private equity funds.

Thus far, LPs have for the most part remained silent – whilst quietly increasing their allocations to the booming asset class. Many of them have very pragmatic reasons for shunning the limelight. Take public pension plans for example, still the most important source of funding to the industry: many barely have the resources to stay on top of the investment process – mounting a campaign to defend the managers in their portfolios would seem beyond their means. In addition, pension funds investing on behalf of workers and retirees are not ideally positioned to publicly praise the return-enhancing efficiency gains that private equity aims to achieve in businesses.

With funds of funds on the other hand, the story is different. These professional private equity investors, whether they're owned independently or belonging to investment banks, do have the manpower to lobby on behalf of the partnerships they invest in. And unlike pension funds, they should also feel free to speak their minds.

More importantly, funds of funds also possess vast amounts of data about the industry, which they could use very effectively to address some of the most common misconceptions. For example: a global fund of funds with a 20-year track record in the asset class could publish average holding periods of portfolio companies in their underlying funds to help prove that quick flips remain the exception rather than the rule. Rummaging in their databases, FoFs should be able to make the case that private equity value creation, exceptions notwithstanding, is still a longterm game.

Another area where FoFs could usefully speak up is in the area of investor relations. In early January, UK corporate governance advocate Sir Derek Higgs was quoted on the front page of the Financial Times, arguing that the growth of private equity raised questions about its accountability to investors and its “poor record” in providing performance information. Professional fund investors responding to Higgs should have pointed to the significant improvements that the industry has already achieved in the area of reporting. They could have argued that as far as the LP-GP relationship is concerned, private equity is already a transparent asset class.

Alas, none of them did – a missed opportunity given the high-visibility platform given to Sir Derek and his views about an industry in which he has not worked. General partners could be forgiven for feeling a little disappointed.