LPs look for edge in specialists, small funds in crowded market

  • Crowded field of GPs presents challenge
  • Plain vanilla buyouts less desirable nowaday
  • LPs try to find an edge 


LPs faced with a large field of GPs said they’re increasing their efforts to find opportunities ranging from smaller buyout funds to investing with firms that operate without a traditional fund structure.

Speaking with Buyouts at the PartnerConnect Southwest 2016 conference in Dallas, these limited partners complained that the high deal prices GPs face are eating into performance. And LPs said that carefully selecting managers remains key to avoiding flat returns.

“As LPs, we believe we have to work harder to find the funds that we think will outperform,” said Patrick Pace, senior director at University of Texas Investment Management Co. Sector-specific funds in healthcare or other industry verticals continue to draw interest from LPs, as they develop their expertise in the asset class.

“It goes back to what you’re really good at — we hired a guy at UTIMCO who’s really good at the consumer sector,” Pace said. “Now we’ll have more depth to evaluate those managers.”

Several executives from large firms have warned LPs to expect falling returns. With more money pouring into the industry, more competition for high-quality deals pushes prices sky high. Andrea Auerbach, global head of private investment research at Cambridge Associates, said a couple of months ago that the current environment made her nervous. “I think a lot of folks think the music is still playing, things are still happening, capital is still definitely coming into the space. What does it mean for returns? As I mentioned, we’re nervous,” she said in September.

In this environment, LPs struggle to get into the highest-performing GPs, whose funds get easily crowded out and raised in a flash. The trick then is to find lesser-known managers, and many times that means smaller funds or funds that target specific strategies.

Along these lines, John Tsui, managing principal of Peninsula House, an alternative manager in the credit space, said at the conference that instead of supporting overpriced buyouts, his firm lends to pet owners to deploy capital. The firm backs loans to help people buy dogs and other pets that can cost thousands of dollars. The investments are safe because people grow more fond of their pets and don’t want to lose them, he said.

“The last thing they’ll do is default on their Chihuahua,” Tsui said.

Gary Post, PE adviser at Andina Family Offices, said the LP is looking closely at payment systems, healthcare services, and data management for healthcare. The LP prefers to build relationships with GPs with ties to businesses in local geographies, while mostly avoiding generalist firms in bigger markets.

GPs are becoming more niche-focused, said Jed Johnson, senior managing director and portfolio manager of private markets for Crow Holdings Capital. “We want to understand how GPs go to the market [for deals] and how they’re sourcing,” Johnson said.

Meanwhile, some LPs look at managers outside traditional private equity structures. Scott Reed, partner at Aberdeen Asset Management, said the firm has worked with independent, or fundless, sponsors on deals. “We’ve found some good opportunities,” he said. The firm also looks carefully at funds in the $100 million to $300 million range.

Scott Bigham, managing partner at Serve Capital, said the firm has been focusing on SBIC funds to tap into growth in smaller businesses. Overall, he prefers funds of $400 million or less, with a focus on software businesses.

“We look for operational capability … more sector-focused groups,” he said. “Everyone has had to up their game to make the math work in this environment.”

Overall, GPs that stay below $10 million in EBITDA for their target companies may avoid some of the pricing pressure in buyouts, he said.

The comments came during various panel presentations at the ninth annual PartnerConnect Southwest 2016. The conference drew attendance from nearly 300 private equity GPs, LPs and service providers at the Joule Hotel on Nov. 30 and Dec. 1.

A worker gathers rose petals on a rose field near the village of Pevtsite, Bulgaria, on May 22, 2015. Bulgaria is one of the world’s leading producers of rose oil, a key ingredient in perfumes, according to local media. Photo courtesy Reuters/Stoyan Nenov