Where does investor appetite lie in the current market?
The relationship between private equity general partners and their limited partners is always evolving, and as we look ahead to 2020, it may be set to change even more.
LPs are taking a more active role, seeking strong, long-term partnerships with their GPs and putting an emphasis on areas that once got little attention. These include alignment, personal relationships, dealing with downturns, planning for disruption, and embracing environmental, social and governance considerations.
Delegates discussed these factors, and more, at SuperInvestor 2019 in Amsterdam, agreeing that ESG will continue to be a focus, with LPs increasingly seeking data and metrics that show the impact their investments are having.
“What we ask our GPs now is to invest with a double bottom line,” said Raphaelle Koetschet, Head of Funds investment at Caisse des Dépôts Group. “The financial outcome and also the impact. It’s to have all that in mind.”
Culturally this can require a shift. GPs now need to dedicate resources to meeting the needs of their LPs, and the key to success can lie in linking their rewards to performance indicators based on ESG metrics. Other LPs use score cards to monitor how the GPs they work with are performaning in this area.
Maurice Klaver, an investment manager in private equity at PGGM, said his firm focuses on broad themes where they want to see a positive trajectory or impact, these include climate, healthcare and food security. Progress is being made and we are measuring it, he said.
While some GPs may find the additional pressures a burden, the LPs agreed that ultimately companies that take these issues seriously will be more profitable, and that will convince any GP who isn’t already on board to get involved.
In many ways, the private equity industry, like others, is learning as it goes. Knowledge can be gleaned from the public markets, the delegates said, where some companies have suffered or been marked down after having poor ESG. To counteract the risk of this happening, better and more consistent frameworks need to be established.
Achieving progress in this, and other areas, hinges on strong relationships between LPs and GPs. Face-to-face meetings and building a good rapport over time are key. Having a good relationship means being able to have difficult conversations when necessary, for example when strategies are changed, or returns don’t come in as expected.
Alignment was a theme, with the LPs saying they want to see GPs backing their deals with their own money, going in alongside other investors. This was seen as a critical path, something that’s not just about data, it’s also about the length of relationships, and really understanding the thought processes and how the returns are being generated.
“We want to explore the motives of why people are coming back to the market,” said Imogen Richards, a partner at Pantheon. “We want to ensure they’re aligned. It’s not just about one stage of due diligence, it’s about continual due diligence and long-standing relationships.”
Raphaëlle Koetschet, Head of Funds Investment at Caisse des Dépôts Group, explains why GPs need to know that it is not an either/or choice between financial returns and sustainable investment.
Knowing your GP has a strong supporting team and a pipeline of good people and good deals is important. Some LPs expressed concerns about fund size, which has crept up, and about the amount of dry powder that some GPs are sitting on, these are both factors that can change the firm’s culture.
“For me it’s not about the rainmakers, man or woman,” said Heiko Bensch, Senior Portfolio Manager, Alternative Investments at Ampega Asset Management. “It’s about the constellation, the social construction of the team.”
To mitigate any potential downturns, the LPs said they like to invest with partners who are also thinking about slower growth before it happens and modelling the potential impact of a recession as well as making sure a buffer has been built in in case valuations are hit.
This also applies to technological disruption – with no areas set to be untouched by digitalisation, LPs want reassurances that their GPs are thinking about it, planning for it and building it in to their investment decisions.
Fully integrated ESG is now seen as a must-have, rather than a nice-to-have. This focus has developed alongside investors’ realisation that taking such factors into account can also contribute to value creation. Among the challenges the industry faces as it continues to fund with ESG in mind is that it needs to coalesce under an agreed framework for measurement,
As the industry matures, the non-financial side will become even more important.
“ESG has to be involved,” said Yolande van den Dungen Portfolio Manager, Alternatives SPF Beheer. “In the end, that is because we believe the underlying companies with good ESG, that are thinking about it and improving it, are better companies.”