Fundraising: Two speed market

Last year saw something of a cooling off in fundraising but it still remained at elevated levels compared with previous years. According to PEI Research and Analytics, some $370.4 billion of total capital was raised, down on 2013’s $423.2 billion, but more than in any other year since 2008, when the onset of the global financial crisis stopped private equity in its tracks.

2013 and 2014 were both underpinned by capital being given back to LPs, combined with a generally positive view on private equity from many institutions, driven by its relative outperformance of other asset classes. Some 43 percent of GPs that declared targets, hit them in 2014 according to PEI, but can the positivity continue for GPs hitting the fundraising trail?

POSITIVE BACKDROP

The view that 2015 will remain a broadly positive one for fundraising is shared by a number of GPs, placement agents and private equity lawyers.

The sheer scale of capital being returned to LPs has led to a scenario where GPs are chasing relatively fewer deals, thus potentially driving up valuations.

That competition for investors’ cash appears to be driving some GPs to get more creative with their fee and hurdle rate incentives as they look to entice an ever more discerning LP investor base.

Adam Turtle, co-founding partner of placement agents Rede Partners, predicts a “robust year” ahead for fundraising despite relatively large amounts of cash being returned to investors.

Turtle focuses on the European market, which is enjoying a relative return to favour, and sees a preference for managers with a proven track record.

“There is plenty of money around although concerns do remain about pricing. We are also seeing more money being committed to a proven manager pool.”

But there are a number of signs that the nature of that fundraising is evolving.
Turtle believes there are two different phenomena occurring at the same time, in terms of the enticements currently being offered by GPs, which are dependent on the relationship dynamic between the LP and the GP.

“LPs with leverage in a fund will be expecting a fee discount, or using co-investment to lower fees. Those GPs who are successfully raising plenty of capital are going the other way and starting to charge a premium because they like the area where they are investing and don’t need more money.”

Andrew Tymms, head of Bain & Company’s London private equity practice, agrees that the desire to invest with the biggest and most successful players is why a focus on fee reduction is not as widespread as perhaps anticipated in 2015.

POWER SHIFT

He tells PEI: “The power has shifted to LPs but there is still a big appetite for investing with the top names. Fee levels have not come down as much as many first thought and the 2&20 fee model has not changed that much.”

He has also notes the trend for the big players to be able to entice certain types of institutional investors such as insurers, with longer duration, but lower return vehicles that best suit their time horizons.

Tymms expects to see a continued trend of polarisation in the rate of raising in the private equity world with the top quartile continuing to find fundraising easier.

“The top quartile are raising rapidly. We are seeing around one third of funds hitting their targets in less than one year while about 25 percent are taking between one and two years. The remaining 40 percent take longer and are coming out with less than their target.”

But one GP partner at a London mid-market buyout firm tells PEI there has already been a significant shift in the balance of power between GPs and LPs in terms of contract negotiations.

The source tells PEI: “Terms are getting more creative and there is a sense that the market is moving away from the same terms for everyone. More GPs are trying different ways to satisfy investors to encourage a greater capital commitment. Now LPs are getting 100 percent of fees as an offset on the management fee. In other words, they are more aligned with the GP.”

The bifurcation in the market, between the top quartile alpha generating big names, and the bottom 40 percent of relative underachievers makes the overall picture of fundraising a complicated one, but the GP also believes that with distributions back to LPs at prevailing high levels, money needs to be invested, so in terms of fundraising, there will be a lag effect.

“There is a lot of money to put to work. The big European firms have not been out this year but right now, this feels like a positive environment. The backdrop of bad news flow from Europe remains a threat to that however.”