LPs sound warning over private equity performance

It could hardly be considered surprising to note that limited partners are not satisfied with the current performance of their private equity portfolio - even their general partners could scarcely say that. But the results of the Winter 2009 Coller Capital Barometer, an LP sentiment survey produced with private equity consultancy IE Consulting, makes grim reading nonetheless.

Half of the European and Asian investors into the asset class surveyed for the report indicated that private equity was now viewed less favourably within their institution, while close to 60% of European LPs and more than 75% of Asian LPs respectively stated they were dissatisfied with recent performance.

There was an interesting divergence here with North American LPs, who were much more sanguine about their portfolio. Less than 30% of such institutions reported that private equity was viewed less favourably, while less than 40% said they weren't satisfied with current performance. That the US is further through the economic cycle than much of Europe could perhaps provide hope that sentiment will turnaround here next year.

Back in the here and now, the dissatisfaction with performance is tellingly mirrored by a sharp fall in returns expectations. The proportion of LPs expecting annual returns of more than 16% has dropped to its lowest level since 2004 on just 29%, down from 43% last year.

Despite all this, respondents did indicate that they were likely to maintain their current target allocation to private equity, with 70% stating that they would keep the status quo. This, though, masks a significant uptick in the number looking to decrease their target allocation, which has more than doubled from a stable 5% to more than 10%, and a decline in those looking to increase their allocation, which has more than halved from around 40% to less than 20%.

As a result of these growing concerns, the demands placed on fund managers by their LPs is increasing. Almost half of all LPs surveyed said that they are now demanding improved reporting from GPs, while a similar percentage have increased their pre-commitment due diligence processes since the summer (see graph).

There was a more positive note sounded in terms of primary investment prospects in 2010, with the vast majority of US and European LPs (84% and 75% respectively) expecting a large growth in capital calls in the coming year, with a clear majority of Asian investors (57%) agreeing. There was also a general consenus that the 2010 investment vintage would prove profitable, with 94% of those surveyed suggesting that investments completed will prove to be good or excellent.

However, this optimism over investments was tempered with caution over exits, with two thirds of investors expecting only a slight pick-up in divestments.

This could be good news for secondaries, as its raises the spectre of LP defaults. Investors have not missed this apparent opportunity: a third of LPs have increased their exposure to secondaries over the last two years, while only 4% have decreased.

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