GP relationships under scrutiny

The poll of 49 LPs and 31 GPs found both groups expect average IRR to fall by 5-10% in the coming years. Two thirds of LPs expect IRRs to fall, and GPs are even more pessimistic, with 73% making the same prediction. While this is likely to worry both investors and GPs, most LPs plan to continue making allocations to private equity funds.

What is expected to change is the type of funds LPs are interested in, and specialisation is likely to increase. Over 70% of LPs surveyed say they wish to narrow their GP relationships and reduce the number of funds in their portfolio to avoid a reduction in returns.

"Private equity will remain a key source of diversification for institutional investors but in an environment of falling expected average returns combined with a greater dispersion, careful General Partner selection will become even more important," says bfinance head of research and development, Olivier Cassin. He goes on to say that LPs will move from their current passive attitude towards private equity investments to take a more active role in identifying the managers that can generate consistently high returns.

Despite GP pessimism on the overall outlook for fund returns, they were rather more optimistic when it came to their own investments. More than half did not expect their own portfolio to see a fall in returns, and 97% expected to increase their assets under management over the next five years.

As many private equity houses are set to hit the fundraising trail in 2011, they should be mindful of the changing appetite among investors. In a highly selective environment, fund strategy, track record and ability to generate above average returns are more important than ever.

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