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As this survey went to press, the industry’s US lobby group American Investment Council was speaking at a House Committee on Financial Services hearing entitled “America for Sale? An Examination of the Practices of Private Funds.”
The hearing was the latest in a back and forth between the industry and the political sphere that arguably kicked off with the collapse of Toys ‘R’ Us in late 2017 and escalated mid-2019 when Democratic presidential hopeful Senator Elizabeth Warren unveiled a bill she co-wrote called the Stop Wall Street Looting Act. If enacted, it would fundamentally change the way the private equity industry operates.
This dialogue between private equity and politics is set to continue — and reach new heights — in 2020. At times like this, getting into the minds of limited partners is more important than ever.
That’s where Private Equity International’s LP Perspectives Survey, one of the most comprehensive of the private equity investor universe, comes in. (PEI is a VCJ sister publication.) For this 2020 study, PEI’s Research & Analytics team surveyed 146 institutional investors to find out what drives them, what worries them, and how they see the future of the asset class.
CONFIDENCE IN PRIVATE EQUITY
While the headline numbers look strong, investor confidence in the asset class has actually dipped slightly from last year: Just 23 percent of LP respondents expect their private equity portfolio to exceed its benchmark in the next 12 months, down from 41.5 percent last year. Meanwhile, 11 percent expect performance to fall below benchmarks, compared with 8.5 percent last year.
This may be a reflection of both the strength of public markets and increased valuations, leading many to think the last few years’ vintages are likely to post lackluster performance.
A TOUGHER SELL
With LPs clamoring to put more money into PE as it becomes harder for them to meet their actuarial returns through more traditional investments, it is easy to think investors must have made their peace with the asset class’s relatively high fee burden.
Not so. In perhaps a sign of increased scrutiny on the industry in the last year, 73 percent of investors agree that fees charged by private equity funds are difficult to justify internally — up 10 percentage points from last year.
DRIFTING FURTHER AWAY
Last year we wrote that ‘style drift’ — GPs extending their strategies into different sectors, market segments and geographies — was a tell-tale sign that we’re late in the cycle, and 2019’s robust fundraising environment has again seen managers strike out into adjacencies, either within the confines of their flagship fund or through new vehicles.
That alarm bell has grown louder this year, with 68 percent of respondents indicating they’re seeing occasional examples of this among their GPs, up from 55 percent last year.
THE RECESSION IS A LOOMING SPECTER
Private equity has been stuck in a perpetual state of ‘late cycle’ for the past few years. For some, that has led to a false sense of security. But this year was different. In mid-August, the yield curve inverted — long considered a harbinger of a recession — but then in autumn it righted itself. Could 2020 be the year the market finally turns?
LPs are certainly concerned about it. Almost three-quarters of respondents list a possible recession in core markets as the factor likely to have the greatest impact on performance over the next 12 months. This was followed by the US/China trade war.
LPs ARE NOT A FAN OF GP STAKE SALES
GP stake sales have been big news in private equity over the last 18-24 months. According to data from Bain & Co, firms focused on the strategy expect to raise around $14 billion this year.
But LPs aren’t necessarily fans of the practice. In fact, 45 percent of respondents indicated that selling a stake to an outside investor makes a GP a less attractive investment partner. Just 12 percent said it made a GP more attractive.
WARREN ON THEIR MINDS
Warren’s proposed Stop Wall Street Looting Act has easily been one of the biggest industry talking points this year, so we asked LPs how they view several policy change ideas proposed in the act.
Respondents were most in favor of prohibiting deals for LPs that are not offered to all investors and eliminating monitoring fees. At the other end of the spectrum, investors were most against stopping tax deductibility of interest payments and, unsurprisingly, oppose the provision that would force GPs to publicly identify investors.
GOOD DILIGENCE TAKES TIME
LPs are notoriously short of time, with very small teams — sometimes just a couple of people — fielding hundreds of calls and PPMs and co-investment requests. Respondents said that for private equity they are presented with an average of 98 fund opportunities per year. But what’s taking up the most time?
For 64 percent of respondents, fund due diligence requires the greatest amount of their time, followed by portfolio monitoring at 48 percent. What’s not a big time suck? Policy development towards considerations such as ESG.