1. Are you concerned about high deal prices eating into returns of recent vintage private equity firms?
We get paid to worry. We worry when people can raise $15 billion without breaking much of sweat. The last time that happened [in 2006-2007] the result wasn’t that great. We are concerned about the $1 trillion in dry powder out there. But on the positive side, private equity transaction volume has been modest.
2. You routinely hear pitches from private equity firms looking to win commitments from big LPs. Any advice you could share?
Don’t go out there prematurely. It’s always best to fundraise with momentum, with the proverbial wind behind your back. So, have some exits in the bag that validate the team, approach and strategy.
3. Touching on TorreyCove’s annual private equity study, any types of funds that seem to be more in favor in 2015?
History shows that those that do the best in private equity are contrarian. The hard part of our business is that we have to think in five-year chunks of time [the typical investment period for a fund]. Given where we are in the economic cycle, at some point, distressed debt will make sense. Energy is topical and should correct sometime in the next five years. Also, playing the strong dollar.
Middle-market buyouts is always interesting. Venture is frothy right now: There are 50 firms that always seem to do well, [but] it’s a struggle for almost everyone else in venture. Short term, understanding the impact of banking regulations and the disappearance of GE credit could be disruptive.
4. A recent study called Reputational Risk in Private Equity (RRiPE) Index showed LPs are more concerned about governance than social and environmental problems. Ills such as “neglecting/abusing the elderly or vulnerable” rank near the bottom of LP concerns, while the “production of hazardous waste” placed dead last. Bribery ranked No. 1 in terms of its impact on fund decisions. Any reaction?
Although ESG [environmental, social and corporate governance issues] has been around for awhile, ESG is still in its early days. We think ESG will be supported by more major LPs in the next couple of years. Ultimately, it’s hard to argue against complying with laws, reducing the impact of climate change and promoting greater diversity and wage equality in the work force.
5. How do you weigh in on the passion for co-investments by LPs to help reduce fees? Some studies suggest the returns from these investments may not always be as good as expected.
Co-investments shouldn’t be just about fee reduction. It should also be about investment return enhancement. Bad investments are made when investors lose their discipline and drift outside their sweet spot. Examples are deals that are too big, industries [with which] they are unfamiliar, and geographies that they are uncomfortable operating in.
Our clients that have taken a disciplined approach to co-investing have done quite well. Finding groups they are comfortable with, co-investing only in deals that are in the sweet spot of the GP, and staying consistent with a vintage-year plan.
Edited by Steve Gelsi