LPs look beyond performance

A consistent record of great performance might not be enough to earn a fund commitment in today’s fundraising environment.

When multiple firms with similar, strong track records vie for the same sources of capital, they need to work just a bit harder to earn commitments.

The problem is – LPs are paring down the number of relationships in their portfolios, and many of them don’t have as much capital for private equity as they did in the past – so they don’t have the inclination they may once have had to simply commit to multiple managers with strong performance.

Instead, they will choose one, and when drilling down beyond performance, LPs are looking for other reasons to pick one manager over another. This dynamic has made strong transparency, reporting and communication practices more important than ever, according to delegates at Private Equity International’s annual CFOs & COOs Forum in New York Thursday.

“It’s not all about returns anymore, it’s about the entire package and LPs have so many choices today that they have the ability to think about the whole package and not just, ‘I’m top quartile’,” said Erik Hirsch, chief investment officer at consultancy Hamilton Lane, who spoke at the conference.

Unless you have the single greatest performance in your market segment, there are other factors people are grading you on and back office and transparency are going to become more of a factor. 

Erik Hirsch

Hamilton Lane has data on funds that are not uniformly available to the industry, which gives the firm a perspective on comparative performances across the board.

“Unless you have the single greatest performance in your market segment, there are other factors people are grading you on and back office and transparency are going to become more of a factor,” Hirsch said.

LPs also have a hard time accurately measuring performance, Hirsch said. “We’re in an industry where the benchmarks suck. LPs can’t distill the information uniformly or consistently to tell who is best of breed, it’s almost impossible. Every firm is top quartile.”

If there were a universal benchmark, “we could rifle through and fire a bunch of people and not re-up with them”, he said. Instead, every firm “tells everybody they’re terrific and people have no idea if they’re not. If you’re a good fund and you have good returns, there are a lot of you out there with good funds and good returns, so it’s a tie breaker.”

The little extra factor that could mean the difference between a commitment or not could involve standardising reporting.

For example, the California Public Employees’ Retirement System (CalPERS) is focused on controlling the cost of private equity. The pension’s Alternative Investment Management Program represents about 14 percent of the total $230 billion portfolio, but about 60 percent of the costs, according to Janine Guillot, chief operating officer at CalPERS. Part of that cost is dedicating resources to monitor and manage the portfolio, which includes 350 funds and 140 GP relationships, she said.

CalPERS would like private market manager reporting to be more like the public markets, where the process of getting information to investors is “highly standardised, highly automated”, Guillot said. The private markets “are still in the dark ages in terms of shipping around this information”.

Public market investment firms such as hedge funds generally use fund administration firms to handle their reporting requirements, companies that invest in the “technology, standardisation and scale”, she said.

“This industry has a lot to learn from the public side,” Guillot said. “I’m a fan of outsourcing in any place where you

I'm a fan of outsourcing in any place where you need scale and technology and standardisation, which is desperately what we need in private equity.

Janine Guillot

need scale and technology and standardisation, which is desperately what we need in private equity.”

The ability for firms to differentiate is imperative in the fundraising market, which is just as crowded, if not more so, than last year, delegates at the conference said.

For LPs, the “math” is going to be hard to do, according to one LP who spoke on a panel at the conference.

“[We have] a huge number of re-ups. Add to that specific GPs we have under consideration as new relationships – say 15 or 20 – and it becomes pretty interesting math trying to bring them all in, or we’re going to have to think hard about not re-upping or having to pass on some people,” the LP said.

The LP said the institution is looking for something beyond all the usual factors like great performance, stable investment team and consistent strategy. 

“We’re looking for that angle that will allow the GP to do the magic they do, whether it’s sector knowledge or sourcing capability,” the LP said.