Record fundraising levels: how prepared are Europe's institutional investors?

It is estimated that around a half of all EUR100m+ European fund managers will seek to raise capital during 2005, compared with the one-third anticipated in an average year. So with groups such as Advent, Apax, Barclays, BC Partners, Bridgepoint, Candover, CVC, ECI, Electra and Montagu all concurrently out in the market, it would seem that LPs have their work cut out. In the current climate one question we might ask is: how is the changing competitive environment affecting the experiences of institutions responsible for screening and selecting funds?

Broadly speaking, investors fall into three main categories: seasoned limited partners, funds-of-funds managers and newer entrants that have not chosen to invest exclusively through funds-of-funds.

Seasoned investors with an established portfolio of good-performing funds are, naturally, well placed to continue their ongoing acquisition of top tier fund interests. The down side to being offered an opportunity to re-up in such funds, though, is that GPs expect a quick decision. But with so many big-name funds in the market, investors are finding it increasingly difficult to assess potential new funds and, at the same time, make investment decisions within the timetable set by their existing GPs.

There is also some evidence to suggest that a small number of investors, with long-term experience of the LP role, do not acknowledge the extent to which the competitive environment has changed in the past year. While all GPs value the support of existing investors, managers of top tier funds no longer need to wait nervously for a response from their LPs when they dispatch their placing memorandum. Not all LPs are aware of the high level of competition from newer investors: there may now be little or no room for negotiation over the fundraising timetable set by the GP and failure to meet deadlines can mean exclusion from the fund. Regardless of any relationship that may be established between GP and LP, especially during hard times, LPs who wish to hold their place in key funds cannot afford to overlook the fact that business remains business. As one fund manager points out: ‘It can be difficult to turn away new investors who are prepared to make a decision well ahead of time, in favour of an existing investor who is dragging his heels.’

On the whole, fund-of-funds managers would seem to have been the best prepared for the influx of fund launches of late. Since such vehicles have been raised on the promise of providing LPs with access to top tier funds, most are well-resourced to complete due diligence within the foreshortened time-frame now demanded by GPs. As ECI’s Janet Brooks comments: ‘We noticed when were raising ECI VIII that the fund-of-funds players were very quick off the mark. They had done their market analysis well in advance and were ready to invest ahead of schedule.’

Newer investors that have opted to manage a large allocation from an in-house team, rather than by appointing a fund-of-funds manager or gatekeeper report finding the recent rash of fund offerings difficult to assess. Given that private equity has not yet proven itself as a good source of returns for this group, gaining access to top performing funds is crucial to their long-term commitment to the asset class. Investment teams typically comprise one or two executives, which was sufficient during quiet fundraising periods to enable these to select the right one or two funds per year from each main market segment. However, as one established investor points out, pressure on LPs from GPs and placing agents to make quick decisions may lead less experienced investors to make unwise investment decisions: ‘The very best placing agents do what they say they do: they carry out their own quality due diligence before offering a fund to an investor and do consider the interests of the GP, seeking to establish good, long-term relationships with investors. However, due to the very nature of the placement agent’s role – IE to assist the GP in raising his current fund - an LP should not rely on due diligence provided by the PA, but should instead use this to support his own. There is a danger that inexperienced and under-resourced limited partners may substitute the agent’s due diligence for his own and may also have a tendency to bow to pressure to make investment decisions before fully researching the legal and fiscal implications of investing in a particular fund.’

Industry practitioners agree that the current fundraising climate, with so many competing funds in the market at one time, is an anomaly. Some commentators compare the current situation to that of the late 1990s’ technology boom. It is unsurprising that experienced investors should be raising questions about some of the investment decisions being made by less experienced limited partners. As Rhonda Ryan of Insight Investment Management comments: ‘Some of the funds on which we have performed due diligence and declined because there were question marks over certain issues, have then gone on to raise significant amounts of capital very quickly and we have been surprised by this. There appears to be a lot of competition to gain access to top-performing funds but the top tier players alone cannot absorb all of this capital. Many investors, in an attempt to deploy capital, are moving down the chain and are allocating significant amounts of capital to second tier players.’

Newer investors, who manage private equity in-house have reported that they are bombarded by fund offerings and have experienced difficulty in distinguishing between top tier and lesser offerings. Where once investors complained of a lack of market information, now there is no shortage, but the challenge is in sorting the valuable from the less so. As John Barber of Helix Associates points out, it is especially important that LPs should not make the assumption ‘that recent high profile, sometimes rapid, very profitable exits are necessarily repeatable in the near- to medium-term. Many of these have been executed during unusually favourable market conditions, particularly for refinancings.’ An excessively backward-looking approach by LPs could come at the cost of overlooking key factors that will influence the future performance of a GP, such as organisational maturity, politics, intra-partner chemistry, motivation, strategy, and response to changed conditions. Also, it is crucial for LPs to establish relationships with key industry the intermediary community, who can provide access to funds at the very early stage before fundraising begins in earnest, when many top offerings secure sufficient soft circle commitments for a first close.

There is no doubting that the presence of a large number of funds currently in the marketplace and those anticipated over the coming months is creating a challenge for Europe’s LPs. But, as John Barber points out, despite the increased pressure on investors to review and select funds, there are some advantages: “Limited partners have very up-to-date track records for the funds they are considering from the same peer group, which can allow for much clearer comparisons between competing funds. In helping to raise Bridgepoint’s recent fund, we found that investors were comparing it with others in the market on a much more detailed level than is customary. The key for investors would seem to be the ability to access the necessary resource and expertise in order to make fast and effective investment decisions, whether this is through funds-of-funds, intermediaries or a sufficiently large and skilled in-house team. For some, though, it may be too late. Gaining access to top tier funds is a long process and investors that cannot move swiftly are likely to be sidelined in today’s competitive environment.

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• Topics
• Fundraising