- LPs overwhelmed with re-ups as GPs come back earlier
- Some seeking ownership in GPs tied to fund commitments
- More consideration of uncorrelated assets, credit strategies
John McCormick is a partner in the Boston office of Monument Group, with responsibility for investor coverage in the U.S. and Latin America.
1. What’s been driving the record fundraising pace?
One of the key factors that I’m hearing more of from talking to LPs is the surprising rate at which GPs are coming back to market. They are overwhelmed with re-ups as GPs seek to take advantage of the interest and the demand by coming back much sooner than expected. I’ve had some LPs say, “We’ve got GPs that are coming back that are only 50 percent committed, some even less so, but just to take advantage of the market. …”
Therein lies an interesting topic: how are GPs allowed to come back when documentation would seem to suggest, contractually, they need to be 75 percent committed, but in some cases they’re coming back earlier? In some ways there is that element of bringing forward some of the funds that otherwise probably would have been raised in 2018, or even later.
2. What can LPs do about such quick returns to market?
They have a choice as to whether or not they want to stay with a manager, and that means they have to commit earlier, or they’re going to miss out on that particular opportunity.
We still live in the world of the haves and the have-nots. For those GPs who are still outperforming, they’re able to manage the demand and call the shots because LPs are gravitating towards and maintaining their spots with these managers. The key issues will be the age-old ones of fund size and performance.
[Where] we see a little bit of differentiation, having raised several funds these past several years at their caps and having been oversubscribed, is in new areas. For instance, Japan is coming back in several ways. We raised a buyout fund that closed at its cap, oversubscribed, [called] CLSA Sunrise. We also raised a lower-middle-market fund, Union Capital, seeking sourcing in the micro-market, targeting much smaller deals.
3. What should GPs do to differentiate themselves in this market?
You hope they’re not doing untoward things to change to attract capital … that GPs are sticking to their constant strategy and staying disciplined. LPs don’t like it when GPs drift in strategy and approach. [There are] certainly ways to do things better, and there are evolutionary ways to change — maybe going down-market to do buy-and-build — that they wouldn’t do otherwise but still within their core competency … finding ways to do their business better, given how challenging the sourcing and deal market is, whether it’s through operational change or approaching the market in a different way but with the same overall strategy.
4. What are LPs’ biggest concerns with respect to fund terms these days?
Fees remain the primary concern for limited partners. Whether it be the overall management fees being charged or the offset treatment of fees being generated by the GP from underlying portfolio companies, the overall sensitivity to this continues to be highest on the list of LPs’ terms.
While this has not really changed over the last couple of years, it has resulted in more LPs creating programs to reduce their fee load. In some cases LPs have created direct co-investment programs where they can invest capital at discounted or no fee and carry terms to average down their combined fees associated with their manager. We are also seeing the emergence of LPs seeking to structure deals in which they take ownership in the GP tied to their fund commitment to position themselves in a way to gain access to the fees being charged by that GP. We expect these types of relationships to grow as they become more accepted in the market.
5. Are LPs more interested in uncorrelated assets, given anticipation of a possible market turn?
More and more LPs continue to research the opportunity set of uncorrelated assets. While we don’t see a groundswell of demand for one particular strategy, most seem to be at least considering more for a portion of their portfolios, be that litigation finance, royalties, life settlements or restoration and land mitigation opportunities. Some are a better fit for a PE portfolio than others but most LPs are willing to look.
Another way investors are managing their anticipation of a market turn that is not necessarily uncorrelated is a shift in attention toward income-producing opportunities, especially credit strategies. We don’t believe they are free of risk given their correlation, but it seems to be a near-term way to satisfy some of the bearish concerns and rightly or wrongly gets at the fact that traditional private equity is overpriced.
Photo of John McCormick courtesy of Monument Group.