Limited partners aren’t entirely pleased with general partnerships, especially when it comes to the thorny issues of management fees and communication. At the same time, LPs say they feel more in charge of their GP relationships and have the power to make improvements. That’s the gist of our third annual LP Survey & Report Card.
LPs say they’re getting better terms from GPs, ranging from voting rights to key-man clauses to fee splits to waterfalls. There is a sense that LPs are driving relationships with fund managers. Outside of the very top firms, where LPs admittedly bite their lips and accept whatever terms are offered, LPs are going into new fund relationship discussions prepared to hang tough until they get the terms and agreements that they want.
Our survey also found that LPs are turning over their GP relationships at a
faster rate than ever before. In their search to improve their returns, more and more
LPs say they’re willing to kick out their worst performers (or even those who merely return invested capital) and try out new GPs. Nearly all (98%) of LPs in our survey report that they added new managers this year (Fig 1). In fact, our average respondent added 15 new managers this year and met with 114 different managers. That’s a lot of tire kicking.
Finally, more LPs are choosing not to re-up with existing managers. Asked if they declined to participate in the past year in a new fund being raised by a manager they have previously supported, 88% of the LPs surveyed responded with a yes, up from 71% last year (Fig 2).
Not only are LPs feeling in more control, but they’re also feeling optimistic. Their expectations for venture returns are the highest they have been in three years. When we first asked about return expectations in 2003, the majority of respondents said they expected returns in the 10%-14% range. That outlook improved in 2004, and shot up even more this year: Most LPs say they expect returns in the 20%-25% range (Fig 3).
LPs are overwhelmingly happy with the returns that their GPs are making for them. This was the first year that we asked a general question about “satisfaction with returns.” Most gave a solid grade of B to returns, making it the single most positively graded response in our entire survey (Fig 4).
Over the last six months we have been told repeatedly that buyout returns are driving this satisfaction (Fig 5), but as we closed this year’s survey we began hearing good things about VC returns, as well. We didn’t know that words like “phenomenal” or “great” were in the vocabulary of LPs.
Meet The LPs
We were successful once again in securing a broad representation from the world of LPs. Forty-five LPs- three more than last year-responded to our survey. The largest group of respondents was pension funds, with strong representation from both public and private sources (Fig 6). The second-largest group was funds-of-funds, endowments, not-for-profit organizations, and foundations. Next came financial institutions, insurance companies and corporate LPs. Finally we added a new group this year: non-governmental organizations (NGOs). We’re especially happy about the input from NGOs, not only because they’re such large investors, but because of the breadth of their oversight of private equity funds around the world.
The typical LP who participated in this year’s survey manages $5.4 billion in private equity investments and participates in 80 different managers with 161 different funds (Fig 7). Overall our participants represent $229 billion invested in private equity and more than $2 trillion in assets.
Geographically speaking, our LPs are almost equally divided between those who we classify as U.S. LPs and those who we classify as global, European or Asian LPs (Fig 8). In the course of this year the LPs in our survey estimate that they will meet with 114 different fund managers in person and add 15 new managers to their portfolios. That’s a lot of meetings. “We probably won’t see that again next year,” says one LP. “This has been the big year for fund-raising.”
While allocations to buyouts-always dominant in absolute dollar terms-have remained stable over the last two years, venture capital allocations have declined as a percentage of overall private equity assets being invested (Fig 9). As you might intuitively guess, the actual dollar amount being invested in venture capital is increasing, but LPs tells us that a smaller percentage of their PE allocations is nevertheless going to venture capital. There are several reasons for this, the most obvious being that the size of most VC funds has decreased over the last few years. At the same time buyout funds continue to grow, absorbing an ever bigger share of private equity dollars. A third factor is the decision by a growing number of LPs to increase their allocation for special situations and opportunities, including direct investments, real estate, PIPES, hedge funds and distressed situations.
We hear from more and more LPs that they make better returns from co-investing or in direct investments than they do by participating as LPs in other managers’ funds. The spate of recent real estate funds by firms such as Carlyle and direct investments by firms such as Singapore’s Temasek represents a growing movement into this lucrative segment of private equity.
For the second year in a row, LPs told us that they are interested in investing outside of the United States-in Europe, Asia and elsewhere. China and India are the two countries at the top of their list of non-U.S. areas of interest (Fig 10).
We added three new questions this year. In the first, we asked LPs to identify their primary concerns in terms-and-agreements discussions with GPs (Fig 11). Unsurprisingly fees topped the list. But we were a bit surprised to hear as much as we did about key-man issues (the second most-cited concern). Coming in third were concerns with conflicts of interest, mainly focusing on the participation of GPs on outside boards.
Our second new question: Should the Securities and Exchange Commission regulate the private equity business? We expected close to 100% of LPs to say no, but 21% of our respondents said yes (Fig 12).
We were surprised yet again by the response to our final new question: Are LPs encouraging GPs to adopt the valuation guidelines endorsed by the Institutional Limited Partners Association (ILPA)? For all the complaints about a lack of standards, the response to this question was mixed (Fig 13). Just over half of the respondents (52%) saying that they don’t encourage the use of the new international valuation standards. This is clearly an issue that LPs continue to wrestle with.
Now, on to the Report Card …
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