LPs throw out the old for the new

This week, CalPERS has made it perfectly clear to all those involved that the fundraising environment this year has the potential to become one of the most difficult the private equity community has ever seen. In a meeting on the 16 February, the US pension plan decided to reduce the number of private equity firms it invests with in an effort to increase returns and trim costs. The LP will now either sell some of its assets on the secondary market or simply refrain from re-upping with managers with whom it is not pleased.

CalPERS has about 130 managers in its alternative investment programme and has set a June 2010 deadline to "prioritise and streamline relationships" - in other words, allocating a larger portion of capital to those top performing managers, which could mean forming entirely new LP/GP relations.

If it was just one LP considering these plans, the story might be very different. Unfortunately, these plans are now circling in the boardrooms of a wide range of investors, according to Janet Brooks, managing director of placement agent Monument Group: "GPs that go out to fundraise in 2010 may find that their existing LPs are not as loyal as they once perhaps were. As a result, there will certainly be fewer re-ups and it is very likely that some relationships will be scaled back. We think that many LPs are going to divert some of the capital that would have been earmarked for existing GPs into new relationships."

The result could mean GPs have to work twice as hard to convince existing LPs of their merit, as those managers that followed the herd during the boom years will not be looked upon too favourably. In May, CalPERS initiated a review of its relationship with buyout house Apollo Global Management, re-examining fees, the fund's performance and the relationship in its entirety. The private equity house is known for having invested in casino group Harrah's Entertainment in 2008, which saw its profits slide dramatically during the downturn.

Following Joseph Dear's appointment as chief investment officer of CalPERS in March last year, the pension fund has been reorganising its alternative investment programme, notably by shedding $2.6bn worth of non-core assets. Senior investment officer for alternative asset management at CalPERS Leon Shahinian was quoted during the recent meeting as saying: "We need to continue to select the best managers and invest the most money with those managers."

Indeed, LPs are now more demanding than ever in their fund manager selection. Speaking to unquote" in December last year, Charles Soulignac of Fondinvest Capital explained his selection criteria: "The best indication of the true skill of a GP is when a fund is quasi-liquidated, with performance indicators (multiple, IRR) over a defined period of time. In the current environment, it is pleasant to see cash in (due to some exits) and cash out (due to some investments), showing that the portfolio managed by the GP is not ‘under water'."

This means that having funds that performed well from 2005-2007 is not sufficient to secure a GP any re-ups, as the latest vehicles (with a vintage year of 06', for example) are seen as a test of managers' ability to invest throughout a cycle.

Moreover, there is also an emerging trend among North-American pension funds to bulk up co-investment activities as a way to decrease costs. CalPERS is not the only investor to consider this move: Canadian investor Ontario Teachers recently completed its first ever buyout in Europe as a means to increase its direct investment activities.

For an in-depth look at fundraising prospects for 2010 read the March issue of Private Equity Europe.

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