he Alternative Investments Thought Leadership Group hosted the PE Emerging Managers Case Studies – The Allocators Respond
event with a terrific turnout and high audience engagement on July 27th, 2017.
Tim Cunningham, President of Touchstone Group, LLC, moderated the discussion with several private equity allocators based on three case studies which described a number of critical issues emerging private equity fund managers encounter in raising capital.
Touchstone, which sponsored the event, raises institutional capital for illiquid alternative investment managers employing private equity and venture capital strategies.
Panelists: David Chiang, Marcia Haydel and Gijs Van Thiel
Mr. David Chiang is Managing Director and Global Head of Private Equity & Real Estate Fund Investments at a large, globally-focused family office.
Ms. Marcia Haydel is a Managing Director of Performance Equity and a member of its Investment Committee. Performance Equity Management is a leading global private equity firm providing private equity investment access, both partnership and direct, to institutional clients worldwide.
Mr. Gijs Van Thiel is a founder and Managing Partner of 747 Capital. Founded in 2001. 747 Capital is a New York based niche private equity firm that is solely focused on making primary LP commitments as well as secondary and co-investments in the North American small cap buyout market.
This panel discussion was unique in a sense that the moderator Tim Cunningham and his team used hypothetical case studies to guide the discussion. The panelists all have significant private equity experience, making for a one-of-a-kind discussion that encompassed an insider’s view of what factors govern institutional private equity investment commitment decision making.
The lively give-and-take among the panelists, the audience and Mr. Cunningham elicited candid and contrasting views that illustrate a diversity of opinion in making private equity investment commitments. No answer was 100% right or wrong. What was acceptable to one allocator may not have been acceptable to another.
Key points of the discussion included:
Overall Manager Selection Criteria: Prior to making an investment commitment, Limited Partners (LPs) have a difficult task assessing the performance of a commingled blind pool partnership. Mr. Cunningham noted that the three most critical elements of the investment decision are: 1. Team, 2. Strategy, 3. Track Record. It is important to note that two out of the three attributes are qualitative rather than quantitative, and the first two attributes ultimately determine the quantitative track record outcome. It is crucial that the LPs pick managers who can outperform in good and bad markets and communicate honestly. As one panelist pointed out, “Finding the trusted partner, people come first, it’s all about the team.”
Generalists vs. Specialists: The consensus clearly preferred sector funds with deep domain expertise rather than generalists. While many diversified strategies are employed by many managers, and while those General Partners’ (GP) teams may well have expertise in a few sectors, it is unlikely an emerging GP will have the requisite deep domain expertise across each of those sectors.
Co-Investing Alongside the GP: Everyone wants to co-invest alongside GPs, but few institutions have devoted the internal resources to actually get there! Since Co-Investing has been a hot topic, no surprise that this was one of the discussion points. The principal motivation for LPs to co-invest is to reduce the overall blended cost of a relationship with the GP. If the LP is invested in the GP’s fund on a primary basis, their co-investment commitments are usually made without a GP management fee or carried interest being charged on that co-investment. There are many ways to co-invest, however, the panelists noted there are numerous key questions to ask are: Why are you being asked to co-invest? Does the co-investment relate to the GP’s core competencies in terms of size, sector, and stage of development? What can a GP expect from a given LP in order to get the deal done? Will the LP do any diligence themselves? Can the LP make a decision within a tight timeframe? And is the amount and structure of the co-investment in line with the LP’s objectives and circumstances? One current trend in Co-investing is among family offices and other LPs doing direct deals. This stems from the increasing sophistication of the in-house professionals in family offices and the tremendous growth of private markets.
Negotiation of Partnership Commercial Terms: The panelists all agreed they need to think about the totality of the partnership, including all the LPs (regardless of the size of their commitment) and the GP in that equation. The point was raised that big investors can swing their weight around and they demand GP concessions in return for a sizable commitment. Often, larger LPs will negotiate side-letters with conditions that can be detrimental to other LP’s. That said, the other LPs do take notice when smaller investors are denied fair economics and governance.
Consistency & Persistence of Returns: The topic of consistency and persistence of returns was brought up. The LP’s all believed that they should challenge all marks, with more scrutiny on high marks than low marks. One panelist stated, “Most GP’s don’t want marks below costs.” While a mark-down may reflect a fair reassessment of investment value, write-downs during marketing are likely forced upon GPs by auditors, which could signal a worse-than-expected situation.
Interest Rate Effect on PE Performance: We have seen a low interest-rate environment for the past 30 years. “It gets interesting when interest rates rise, that is when you see who the managers are that can outperform.” During the post-panel networking I asked the same panelist at what level of interest rates would there be a significant, adverse impact on these PE deals performance?” As that old saying goes, only time will tell…
The event was organized by Steven G. Bloom, CFA, a volunteer and former co-chair of CFA NY’s Alternative Investments TLG. He is a Senior Portfolio Manager at ARC Fiduciary, a start-up private equity fund raising capital to invest in sustainable energy development projects in the U.S. He also performs due diligence on private real asset funds.
Write-up prepared by Henry H. Ngan, MBA, CPA, Steven Bloom, CFA, and Tim Cunningham