LP perspectives

LORENZO LORENZOTTI, MANAGING DIRECTOR, ACG PRIVATE EQUITY

- Given the downturn in the markets, would you as an LP do anything differently now going forward? What advice would you give to a first-time investor?

I would continue to (a) invest with proven managers that have demonstrably made money in both good and bad times; (b) invest with independent managers that are still hungry for success and not comfortable just collecting fees, who want financial success for themselves and to prove themselves to their peers; (c) invest with managers that have been able to build a solid and durable platform that can survive losses of senior partners, and where everyone is incentivised; and (d) "Back to the Future" clear and unquestionable alignment of interests.

For a first-time investor I would remind them that historically the downturns are when the best private equity transactions, and fund vintages, have been made. The learning curve and experience curve in this industry is still high, so I would recommend that they begin with a portfolio approach where the investments will be distributed in a group of private equity funds, diversified over strategy, geography and specialisation. This will lower their overall risk, enhance their return and provide them with a conservative yet truly diversified exposure to private equity.

- What would you say is the biggest change in terms of how a GP treats its LPs now?

Clearly, fundraising has been difficult for all and will continue to be for some time. The funds that will be able to raise will be the ones that have shown their ability during this downturn or prior, either in not having done overpriced/overleveraged deals, or in properly managing their portfolios. In regards to existing funds, the ones with the experience of having been through downturn cycles before are better suited to deal with LP issues and portfolio company situations than others. Experience matters in these times, and it shows.

Being realistic, transparent and humble always wins for a GP, in good times and bad, and LPs know this. In terms of leverage on new fund terms ... well the ball is finally in the LPs' court, although I strongly believe it should have always been there in the first place.

- What is more relevant when assessing the merit of a GP, track record or the current underlying portfolio?

Their track record is important if it is over a period of time that covers various cycles. If it covers the last few years only it may not be as important. The current portfolio demonstrates the team's ability to make the right decision or not, in terms of price, leverage, timing, industry and overall leadership on the board level. They are both relevant but only in a broader due diligence review of a GP.

We would consider both track record and portfolio among a much larger array of objective considerations and detailed review that we perform, utilising our rating system we have developed and refined over time. We then layer in a subjective review based on personal relationships and meetings we have had locally with all members of the management team, their bankers, accountants, attorneys, friends and entrepreneurs they have invested with. It has to be a 360 degs due diligence effort, you cannot rely on one or two elements as being determinants.

- What is the best indication of the true skill of a GP: cash in vs out in the last five years, or current performance (realised and unrealised)?

A fundamental truth of this industry is that cash in and cash out is the true measure of any private equity transaction and fund. It shows how good an investor you truly are at getting a real return on the money you invested. In the last five years it may show good preparation, timing, luck, or all three. But this has to be measured over a longer time period to be able to truly say that a GP has been able to demonstrate that it can make money in different cycles.

Current performance is a good indicator of how good your hands-on skills are, how good your portfolio management team is at dealing with issues, be it management issues, financing, market etc. How good is the GP at protecting value, and creating or enhancing value in a company, across the portfolio? Write-downs are at times part of the growth of the company, and part of every private equity portfolio, especially today, but write-offs are a different story.

Both are good indicators and both need to be looked at, but in a larger scope of review.

JOHN HOLLOWAY, DIRECTOR, EUROPEAN INVESTMENT FUND

- Given the downturn in the markets, would you as an LP do anything differently now going forward? What advice would you give to a first-time investor?

Bearing in mind that the EIF supports the lower mid-market and early-stage venture sectors in Europe, I wouldn't change anything going forward. We've stayed constant with our investment strategy by investing in funds whose main purpose is to provide equity funding to small and mid-size enterprises in Europe. The advice I would give to a first-time investor is to do firm and sound due diligence when choosing GPs. This includes due diligence on the whole market and sector as well as the fund management team themselves. If you are not familiar with the territory, then get someone that is to do it for you. It is not something to shy away from.

- What would you say is the biggest change in terms of how a GP treats its LPs now?

For our part of the market, those GPs that are looking to raise capital now are those who treated their LPs well, even when it was easy for fund managers to raise funds. If GPs tried to play hard ball with their LPs in the past, they will have difficulty raising funds going forward. A GP must report in regularly with an LP and make investors feel comfortable by providing all the information they require.

- What is more relevant when assessing the merit of a GP, track record or the current underlying portfolio?

These two things go hand in hand really. Part of our due diligence is to look at the track record of a fund manager (if there is one). If it is a first-time fund, then we will look carefully at the backgrounds of the senior executives of the team and what each has brought to the table. The current underlying portfolio is a key part of our assessment. We look at where the value drivers in their portfolios are, if they've invested in the right technologies, etc.

- What is the best indication of the true skill of a GP: cash in vs out in the last five years, or current performance (realised and unrealised)?

Again, we look for a lifetime to see what GPs have been up to. Assessing current performance is central, especially with the unrealised portion; it calls for more risk and skill to assess where a GP will be in the next four or five years. It is also important to look at the cash in versus the cash out in the last five years. But in our sector of the market, it is very hard to find a fund manager whose funds have all had consistently good performance. There is always different return data for different funds, and that is just the part of the market we are in.

MICHAEL GRANOFF, CEO, POMONA CAPITAL

- Given the downturn in the markets, would you as an LP do anything differently now going forward? What advice would you give to a first-time investor?

I would have to say that I would focus more on three particular ideas. Firstly, diversification in a portfolio is important, beyond just the usual spread of buyout and venture, in terms of geography and different private equity classes, such as distressed, secondaries and energy. Secondly, LPs have to be more careful about how they choose to invest. GPs that are followers are unlikely to succeed in the years to come. Lastly, LPs should focus on the fact that there is no rush to make an investment now. Time is on our side.

- What would you say is the biggest change in terms of how a GP treats its LPs now?

There hasn't been much change yet, but I can see where these changes will appear. GPs are now concerned about whether LPs are going to fund and whether they will honour their commitments. This is something that has never before been a worry for GPs. Also, access to funds for LPs is not a problem, as you can get into almost any fund you want now, and there have been changes in fee structures for investors. You could say that the balance of power has shifted somewhat to the LP side now, but this is only a generalisation. GPs that are seen as being the best will always be in demand, and they won't negotiate their terms as much because they don't have to. The groups that had to may be examples of adverse selection and therefore not the best investments.

- What is more relevant when assessing the merit of a GP, track record or the current underlying portfolio?

These two aspects are really two sides of the same coin. A GP's current underlying portfolio is their track record going forward. I would say that the past is not a prologue, and if LPs are looking at what funds did years ago, it is not necessarily a good indication of what will happen going forward. Today's economic situation is different, and therefore the criteria of success for a GP will be as well. Currently, an LP might choose to focus on how fund managers work with companies and management to improve performance as well as how they are able to negotiate debt.

- What is the best indication of the true skill of a GP: cash in vs out in the last five years, or current performance (realised and unrealised)?

Neither is sufficient. Current performance is limited by the uncertainty of the value of the unrealised portion. Cash-in versus cash-out in the last five years is only a measure of the past and the world is a very different place now. It is difficult to measure the skill of a GP - there is no algorithm like a+b=c. You have to make your own macro assumptions about what the world is going to look like in the future. LPs have to consider the edge a group has in the current environment. Five years ago, financial engineering skills may have been the best criteria to assess a GP, but now you have to look at a different skill set and the viability of the group in the years to come. Is the same team likely to be around in the future? How are they at deal sourcing and operationally improving companies?

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