It's not just a relationship, it's a partnership
The relationship between a fund and its investors is critical in the private equity world and those relationships have been changing in recent years as the industry matures and as the economic situation changes.
Where once LPs would take a relatively passive role, they’re increasingly seeking more and more information, playing an active role and in some cases taking on more risk.
Having a strong strategic alignment was the overarching theme – with the delegates agreeing that allying interests, building trust and making sure that performance was in some way linked to pay outs, were important factors in any relationship.
Ilona Brom, Managing Director at Wilshire Private Markets, talks to us about the key characteristics they look for in GPs and why the LP-GP relationship today is a true partnership.
As GPs grow larger and diversify their operations, it can be important for them to show their commitment by investing alongside their LPs. As firms seek to diversify their offerings by launching new strategies, the risk is that they stray too far from their core capabilities and stretch performance. Putting in their own cash can help alleviate some of these concerns.
“Investors want to make sure that the GPs have skin in the game and their own personal capital invested in their projects,” said Michael Rees, the head of Dyal Capital Partners. “If you’re raising a big fund, you need to put in a big commitment.”
One such area of diversification is long-duration funds, with some GPs launching vehicles with a life longer than the industry’s traditional 10-year fund model. The panellists said they were open to longer-term solutions, as long as there were no nasty surprises, the strategic alignment was there, and all parties were agreed on the aims of the fund.
“I would like to know from very early on that it’s a long-term thing,” said Michael Lindauerm, the global co-head of Private Equity at Allianz Capital Partners. “I don’t want to find out after 10 years that something is turning into a long-term thing. This is one of the complexities.”
Other areas of diversification include launching multiple product lines, embracing lower hurdle rates, using credit-lines and GP-led fund restructurings.
This proliferation of activities can be positive, since launching products and strategies can present new projects and challenges to existing staff, exciting them and creating ways to retain them, as well as giving the firm broader reach and potentially creating additional returns for the LPs.
Even so, one of the risks is that the diversification stretches the GP too thinly.
“When we get really worried is when we see an awesome fundraising machine that just raises money and then invests, invests, invests,” said Przemek Obloj, Managing Director, PSP Investments. "But ultimately, we are open to new ideas and fundamentally, we want to invest behind the best investors.”
It’s about hunger and opportunity for Naoki Ohta, a managing director at Barings. His firm tries to capture managers and opportunities before others and look for the alignments there.
“We look for alignments where we believe we can capture manager at their hungriest,” he said. It’s also about assessing the wider opportunity. “We’re looking at team, we’re looking at track record and we’re looking at market opportunities as well. And when the stars don’t align, that’s a warning sign.”
Trust and the quality of the relationship with the individuals was a key theme, and there was a sense that in those areas, there is now a focus on the future – for example, assessing who is likely to do well in the next recession or downturn – rather than on track records or past numbers.
“We are looking for a forward-looking alignment,” said Obloj. “What is the incentive structure, how is money being made, how is it being distributed.”
Trust also plays into the distribution of incentives – asking deeper questions about the guaranteed fee income and the potential and carried interest that might become available. It’s no longer just about looking at the monetary aspect, although obviously this is key, but also about the motivation of the individuals involved.
Marc Roijakkers, Senior Fund Manager, Alternatives, Blue Sky Group explores how the LP-GP relationship has changed as macroeconomic factors come into play.
Ultimately there was a broad agreement that each situation is unique and needs to be assessed individually to make sure it makes sense for both the GP and the LP.
“When we make these investments now, we want to make sure that we’re aligned in wanting to see that money put back to good use within the firm,” said Rees. “We don’t have a say in what these GPs do - it’s up to them to decide. We just want to be there to help with capital and share some lessons learned.”
For Lindauerm, it’s all about assessing the liquidity options and being ready to accommodate requests. Some situations can feel “too opportunistic,” he said.
While the relationship between LPs and GPs seems to be evolving all the time, what’s clear is that both sides are embracing the changes and looking to form better strategic partnerships that go the distance. Done well, it can be a mutually beneficial relationship where both sides offer each other solutions.
“I really like to see this type of innovation in the industry, where we begin to offer solutions that look different,” said Dyal’s Rees. “Innovation is a positive.”
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