Side Letter: Is your GP manipulating performance?

An academic report suggests PE firms are more inclined to manipulate portfolio company performance when under pressure to raise their next fund. Plus: Why OPERF isn't deterred by a little overexposure to PE and a French GP is using its management fees to drive impact. Here's today's brief, for our valued subscribers only.

They said it

“Private equity interest has definitely tapered a bit, but it’s still out there. What I think has happened is that there’s really been a flight to quality, where private equity is still interested — but they’ll probably be more discerning around the operator, around the state, around the facility type than before.”

Elliot Mandelbaum, managing partner at US real estate firm Eagle Arc Partners, discusses PE ownership of nursing homes, an area that has come under heightened scrutiny during the pandemic.

Just happened

Under pressure
LPs beware: PE firms are more inclined to manipulate portfolio company performance when under pressure to raise their next fund. That’s according to a paper entitled Do Stressed PE Firms Misbehave? from the University of Sussex Business School. Researchers created a fundraising stress index to assess the level of pressure on GPs based on their financial affiliations, stage in the cycle and fundraising frequency. They concluded that firms with a high FSI score were more likely to engage in “upwards earnings management” (in other words adjusting a company’s cashflows to improve its perceived performance), regardless of their size.

“Our results are also important for public policy and regulatory attempts to increase transparency and prevent bad conduct amongst PE firms,” the report notes. “Given the evidence provided in this study, it is not clear why PE firms are under lighter regulations compared with other financial intermediaries.”

Performance metrics don’t always tell the full story, as PEI explored here. As the pandemic puts stresses on investors, portfolio companies and ultimately returns, greater disclosure and more transparency around performance and fees will become even more crucial.

Provocative stuff. We’d love to know what you think.

Millennials at the wheel
Know any up-and-coming executives likely to be at the forefront of PE’s generational shift? You still have 11 days to nominate them for PEI’s 40 under 40: Future Leaders of PE list, which you can do here. On a related note, a more socially and environmentally conscious generation of executives looks poised to revolutionise the industry’s approach to responsible investing, as we explore here.

Meanwhile, Katharine Preston, vice-president of sustainable investing at OMERS, tells PEI that ESG is not a trade-off for strong returns, but rather a key element of fiduciary duty that will safeguard portfolios and drive value for members. To that end, OMERS was among eight Canadian pension plans that called for improved ESG data reporting by companies and investors last year. “We know that while companies face a myriad of disclosure frameworks and requests, it is vital they report relevant ESG data in a standardised way to provide clarity and improve data flow,” she notes.


Full steam ahead
Oregon Public Employees’ Retirement Fund will maintain a steady commitment pace to PE despite being overweight, sister title Buyouts reports (registration or subscription required). Although PE accounts for 23.5 percent of its portfolio against a 17.5 percent target and 21.5 percent policy limit, the fund committed $2.87 billion last year and is targeting similar in 2021. Meanwhile, OPERF’s overexposure and performance issues are being addressed via a secondaries programme enabling the pension to unload older, underperforming holdings and put some of the proceeds into co-investments. When it comes to portfolio construction, the best defence may well be a good offence.

Forgoing fees for impact
Natixis affiliate Mirova has launched an innovative impact strategy for its fifth renewables fund. Each year, Mirova will give away 4.5 basis points of the fund’s management fees to back projects fighting fuel poverty in France and promoting renewable energy access in developing countries, among others, per sister title Infrastructure Investor (registration or subscription required). Last October, Mirova was awarded B Corp status, a French accreditation whereby signatories have a legal responsibility to balance profit and purpose. As efforts to measure impact continue, perhaps heads should turn to France for best practices.

Dig deeper

Institution: Arkansas Teacher Retirement System
Headquarters: Little Rock, US
AUM: $19.46 billion
Allocation to alternatives: 24.4%

Arkansas Teacher Retirement System has confirmed $90 million-worth of commitments to three private equity funds, according to materials from the pension’s February board meeting.

The commitments of $30 million apiece feature one new relationship for ATRS alongside two funds managed by Franklin Park, an existing manager. Greenbriar Equity Group’s Fund V represents a new manager offering for ATRS, with Franklin Park’s Corporate Finance Access Fund and International Fund X also receiving commitments.

ATRS’s commitments to the two Franklin Park funds represent a pair of re-ups. The pension had previously committed $60 million across two investments in the Corporate Finance Access Fund, alongside $30 million previously invested in International Fund X.

The $19.46 billion US public pension has a 12 percent target allocation to private equity which stood at 13.6 percent as of 31 December 2020.

For more information on ATRS, as well as more than 5,900 other institutions, check out the PEI database.

Today’s letter was prepared by Alex Lynn with Adam Le and Carmela Mendoza.

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