Most LPs seek to improve co-investment appeal – Coller Capital

Founded in 1990, secondaries specialist Coller Capital produces biannual barometers to gauge global LP sentiment. The firm held a USD 9bn final close for its latest flagship fund, Coller International Partners VIII, in January 2021.

The research for the Barometer was conducted from 28 September to 9 November 2021 by alternative assets research team Arbor Square Associates, with 102 LPs surveyed. Of these, 40% were based in North America, 42% in Europe, and 18% in the Asia-Pacific region. The largest groups of LPs within the group were insurance companies, public pension funds, and banks or asset managers, each of which make up around one fifth of the respondents.

The survey included questions on LPs' perception of private equity ownership. An overwhelming majority (89%) of LPs agreed that small and mid-cap public companies would benefit from periodic spells of PE ownership. When it comes to public markets, 80% of LPs viewed PE sponsorship as a positive indicator for the short-to-medium-term prospects of private companies seeking to float on the stock exchange.

Following on from this strong support for PE ownership, the survey assessed LPs' views on co-investments, with 56% of LPs stating that they are taking steps to improve their attractiveness as co-investment partners. The vast majority of these LPs (90%) said that steps they were taking included increasing the internal speed of their decision-making, while half said they were building their expertise in specific sectors or areas of the market.

Katrina Liao, an investment principal at Coller, notes that the co-investment market has developed significantly over the past few years. "LPs are developing their capabilities, and co-investments have come a long way. Many LPs are becoming more sophisticated, in that they don't just take any co-investment that the GP is offering, but they have an in-house view on sectors and can become more picky."

Secondaries in focus
The increasing prevalence of and appetite for continuation funds among both LPs and GPs was the subject of several questions in the survey, with two thirds of LPs expressing the view that continuation funds are likely to prove good owners for most of the portfolio companies that go into them.

A significant minority of LPs (43%) expressed concerns in the survey about the effect of GP-led secondaries deals on the traditional 10-year PE fund model, although the majority (57%) of LPs surveyed thought that the proliferation of continuation funds is likely to strengthen the private markets ecosystem. Says Liao: "I understand the concerns because some LPs don't have the capacity to assess whether they should take the opportunity to reinvest into a continuation vehicle or take liquidity, as they are already overstretched with general portfolio monitoring and co-investment opportunities from their GPs. I don't personally think these concerns will hold the secondaries market back."

The development of the secondaries market is likely to continue at pace, with the PE portion of the market driving innovation. "I am excited to see how the market will grow," says Liao. "The GP-led space is very innovative – even in a year's time, we could be talking about a different structure that GPs and LPs use for liquidity. The PE side of the secondary market has outpaced other strategies, and what we are seeing there will also emerge in credit and infrastructure. The PE side will continue to innovate with interesting new structures and vehicles."

A virtual world
Liao highlights that there were a significant number of questions about cybersecurity and virtual due diligence in the survey, including the fact that 9% of LPs have suffered a cyberattack in the past five years, while 67% expect to face one in the next five. "My conclusion is that this is exactly what LPs are thinking about: virtual due diligence is here to stay, with nearly half of LPs making more commitments to GPs that they have not previously met face-to-face. LPs are also increasingly checking cybersecurity threats and individuals at GPs' social media accounts, which is a sign of the generation."

As reported in the survey, checking social media accounts forms part of due diligence for 29% of LPs, with a further 38% saying that they intend to begin to do this.

When it comes to virtual-only due diligence, a process to which many LPs have had to adapt over the course of the coronavirus pandemic, more than a third of the LPs surveyed said that they will continue to make first-time commitments to GPs whom they have never met in person. Reviewing the past 18 months, 49% of North American LPs confirmed that they had made first-time commitments to GPs without having met them, versus 44% of European LPs and 28% of those based in the Asia-Pacific region.

With virtual meetings and commitments to managers without an in-person meeting becoming increasingly commonplace for many LPs, there is room for emerging managers to forge new relationships. "I think the prospects are good for emerging managers," says Liao. "The reason LPs meet GPs is to get a sense of them, but a lot of the work about understanding their track record, how they plan to invest their fund, and diligence around prior investments, all can be done virtually. The personal touch is lacking, but the process is more efficient."

ESG and regulation
ESG concerns continue to be most strongly expressed among European LPs, according to the survey, with 56% saying that ESG concerns have played a major role for them in rejecting fund commitments, versus 25% of North American LPs and 33% of Asia-Pacific LPs. The survey notes that the proportion of European LPs who said ESG concerns had played a major role in rejecting fund commitments stood at just one third in Coller's winter 2016-17 barometer, highlighting that the role played by ESG in this market is growing.

Correspondingly, European LPs were less optimistic about whether regulatory change will make it easier to distinguish greenwashing from true environmental claims in the next three years, with just 44% considering this a likelihood.

Of the North American LPs surveyed, 51% expect to see more regulation in their home market, whereas 35% of LPs expect the same for their own home market, alongside 33% in Asia-Pacific. However, the majority of LPs (59%) expect to encounter more government regulation of PE outside their home market. "LPs outside the US are indicating that they expect more regulation in the US," says Liao, although she notes that this is not a barrier to commitments. "They don't see it as hindering the investment process; it's about asking GPs how they are factoring any potential changes in regulation into their underwrites – for example, asking if there will be a tax change or a barrier at their exit, taking the risk on board and underwriting accordingly."

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