Fundraising gets personal

The priorities of a limited partner have changed, according to Coller Capital's Global Private Equity Barometer. While declining returns and heightened competition topped their list of worries in 2005/06, continuity and succession issues now weigh most heavily on the minds of LPs, with strategy drift in close second. It seems that amid post-crash precarity, the stress now falls more on the management side of fund selection than the financial returns side. But why?

This focus on personnel and strategy could be a direct result of the falling number of GP-LP relationships. The barometer reveals that 18% of European LPs intend to reduce the number of GP relationships over the next two years, compared to the 5% who stated the same intention in 2006. Yet this is not a symptom of malaise in the face of the asset class. On the contrary, more than three times as many LPs (30%) plan to increase their allocation to private equity over the next 12 years rather than reduce it (9%).

"Investors are becoming more savvy when it comes to the selection of their GPs," explains Giovanni Orsi, investment principal at Coller Capital. "They are really digging down more. The way I see it is you have a lot of cash for the winners. There will be big cheques, for a smaller number of GPs," he says.

Perhaps LPs now give more attention to fund management strategy and personnel as a result of their increasing attention to detail during fund selection. It's no longer a question of natural selection and loosened purse strings, whereby the big winners get the cash. Nowadays, gaining the trust of LPs and reassuring the longevity of a relationship is what will improve the chance of long-term commitment. LPs' heightened due diligence when selecting fund managers means that what they are really investing in is people.

Long-term commitment
And it does seem that once that trust is won, it is fairly steadfast. Almost 40% of LPs say they would back a GP on a deal-by-deal basis, though 18% of them said they would only do this if they had history with the particular GP.

"LPs actually want to keep those relationships with certain GPs," explained Orsi, "38% would consider investing in a GP which they know, which they trust, on a deal-by-deal basis. That is a change from a few years ago," he says. "This means there is a sort of shift or imbalance in the balance of power towards LPs to some extent." It seems, more so than ever, LPs have the power of selection.

Turning the spotlight around, though, reveals that European LPs perhaps could do better. According to the barometer, 63% of North American LPs have performance-related pay, compared with 53% of European LPs. What's more, 55% of LPs with performance-related pay have achieved annual returns of 11% from private equity investments over the last five years. For those LPs whose remuneration is not linked to performance, fewer than one in five boast similar returns.

Alignment, then, is key. "Take a pension plan," says Jeremy Coller, chief investment officer at Coller Capital. "It can only achieve strong returns from private equity by consistently selecting the right managers – and to do that you need talented, experienced and motivated people doing the selecting."

While the prevalence of performance-related pay in the US is most likely linked to the maturity of the market, its relative scarcity in Europe would appear to hamper returns. "I think that [LP remuneration] really needs to change," explained Orsi. "The data shows that those LPs with performance-related pay are more likely to select the better GPs, the winners."

unquote's Kimberly Romaine interviewed Giovanni Orsi during our recent Italian Private Equity Congress in Milan. Click here to hear his take on the secondaries market.

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