LPs' net returns highest since financial crisis – Coller Capital

According to the Barometer, 42% of LPs now have portfolio-lifetime annual returns of more than 16% net; in 2021, just 21% of LPs reported that this was the case.

Since the Barometer was first published in 2004, the only time that this number was exceeded was in the Summer 2007 Barometer, prior to the GFC.

David Jolly, partner at Coller Capital, told Unquote that he does not see cause for alarm in this parallel. “This figure is reflective of the fact that both of these periods saw prolonged good performance, profit and valuation growth, with returns accumulating over a number of years,” he said. “I would not draw any other parallels as the situations are different. The technology market sell-off, supply chain issues and the Ukraine invasion, the unwinding of Covid support measures and so on, are clearly different from the GFC drivers.”

The Barometer includes responses from 110 private market fund investors in North America, Europe, and the Asia-Pacific region (including the Middle East). The research was conducted from 7 February to 30 March 2022 by research firm Arbor Square Associates.

Market maturity
Jolly said that LPs’ interest in PE as a part of their portfolio was a standout takeaway from this summer’s Barometer. “What came through strongly for me in the Barometer is LPs’ engagement with private equity, how strongly they see it contributing to their portfolios, and their enthusiasm for the sector,” he said. “LPs are reporting their PE portfolios are outperforming their public equity and are saying that even with just median fund performance they would have made their targets, which is a strong indication of the performance of the sector.”

Indeed, 55% of North Americans said that their target PE returns would be met with the median fund performance for the relevant fund type and vintage year, versus 67% of European LPs and 86% of Asia-Pacific LPs.

A further reflection of the maturity of the industry is LPs’ growing interest in investing in funds that acquire minority interests in GP management companies. In the Summer 2022 Barometer, 47% of LPs said they were investing or planning to invest in such funds, versus 36% in Summer 2018.

“I think this is a separate trend from the PE industry consolidation M&A that we are seeing at the moment, but both are a reflection of the ongoing development and maturing of private asset management and the PE industry,” Jolly said. “I would tie it back to LPs’ enthusiasm for PE as an asset class and their sophistication, viewing PE as a long term-part of their portfolio and allocation. Some don’t just want exposure to funds – they are seeing the capability for fund managers to be successful entities in their own right and the appeal of being invested directly in the management companies.”

Fundraising competition
The consequences of private equity outperformance for LPs were not addressed by the survey, however, it is “a nice problem to have”, according to Jolly. “Where we have seen this having an impact is the value build-up in LPs existing portfolios, and the fundraising for primary GPs,” he said. “Some activity in the secondaries market is tied to the denominator or similar effects: LPs want to keep committing to their favoured fund managers. We have seen big fundraises this year and many GPs are in the market now, so some secondaries sales will be from LPs rebalancing portfolios to make sure they can commit to their chosen primary GPs who are raising.”

These large fundraises have included Advent International’s USD 25bn vehicle, as reported. US-headquartered GPs including Apollo and Blackstone are also in the market with funds of similar magnitude.

However, in a competitive environment, LPs still have reasons to commit to funds to get their first closes over the line. The vast majority (91%) of LPs have “sometimes or often” committed to first closings of private equity funds as a result of incentives offered by their GPs, with just 9% saying that they had never done this. Competition between LPs was also a factor, with 80% saying that they had committed at a first close due to this. Workload scheduling was also a factor, with more than two thirds (68%) saying that they had committed to a fund at first close as it was convenient for them.

“LPs are clearly having to manage their capital capacity, their workloads, and tight timelines,” Jolly said. “The general macro backdrop, the number of competing funds, and those demands on LPs may present a challenge to some GPs fundraising timelines. However, many groups are still delivering quickly on strong fundraise results. The Barometer has highlighted the appeal and impact of incentivising LPs to come into the first close, such as offering an early bird discount.”

ESG in focus
The barometer also posed questions to LPs on their thoughts on ESG, with the topic regarded as both a value driver and a way to filter out potential negatives of an investment. Almost two thirds (65%) agreed that “ESG adds value by excluding high-risk investments and business practices – and by proactive, positive changes to portfolio companies”, while just 8% felt that the value-add comes primarily from excluding high-risk business practices. Around a quarter (27%) were more sceptical, agreeing with the statement that “ESG responds to societal pressure, rather than adding value to PE investing itself.”

“We were pleased to see LPs’ acknowledgment of GPs’ hands-on role in improving ESG practices and in what the companies in their portfolios do day-to-day,” said Jolly. “This helps to build strong companies and it’s now part of value creation plans.”

Publicly exposed LPs are also increasingly conscious of potential reputation damage arising from their links to PE-owned businesses, particularly from commentators or activists. This is an issue for just 22% of LPs generally, rising to 62% of public pension funds and 56% of endowments and foundations. “This topic follows on from ESG concerns, looking at whether there are sectors that LPs would not allow their GPs to invest in or to be exposed to," Jolly said. "LPs that are publicly exposed, such as a pension plan, foundation, or a state-linked fund, might take the view that they are more of a target for negative exposure if a portfolio business attracts the wrong kind of commentary.”

The Barometer also highlighted ongoing differences between European LPs and their peers elsewhere. Almost two thirds (64%) of LPs in Europe have increased the number of industry sectors they exclude for ESG reasons over the past five years, versus 23% of North American LPs and 24% of Asia-Pacific LPs.

LP environment
The Barometer also posed LPs questions about themselves, including on recruitment and business wear. Around half of the LPs surveyed are changing their pay scales and/or working conditions to attract new recruits, with 51% of North American LPs and 45% of Asia-Pacific LPs saying that hiring high-quality investment staff has become harder over the past two years, versus just a third of European LPs.

On the topic of formal business wear, 42% expect formal business wear to disappear in the wake of the pandemic, while there is a 50:50 split between those who would be happy if this were to happen versus those who would not be.

When it comes to allocations, half of the LPs surveyed said that they intended to increase their allocations to alternative assets, with 42% highlighting private equity as an area to increase, versus 6% saying they plan to decrease their allocation to the asset class. More than half of LPs have increased their PE allocation over the past two years, according to the Barometer. More than a third (39%) intend to increase their private credit allocation, although 10% intend to decrease it.

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