PARTNERS: Ardian BRG Asset Management Debevoise & Plimpton eFront Evercore L Catterton MVision Partners Group SANNE

Co-investment stampede Style drift Gender on the agenda What keeps LPs awake And much more... The Debevoise Private Equity Group continues to lead “Dominant the field, in an industry it has helped shape for decades. global private The practice includes focussed groups experienced in equity practice fund formation and investment management, buyouts and other equity and debt investments, finance, with experience securities and capital markets, tax, and management compensation and employee benefits. advising a More than 200 lawyers work within the Group in offices comprehensive around the world, making it one of the few truly global private equity practices. Teams are lean and efficient, range of clients” and are tailored to the culture, strategy and risk profile of individual clients. Chambers Global www.debevoise.com Why the views of LPs matter have been an opportune time. As master of TOBY MITCHENALL their own destiny, this will not be an issue. EDITOR'S These thoughts play on our minds as we ISSN 1474–8800 LETTER DECEMBER 2018/JANUARY 2019 sit down to plan this substantial survey. Is the Senior Editor, Private Equity limited partner universe as relevant as it once Toby Mitchenall, Tel: +44 207 566 5447 [email protected] was, given that some of the most established Special Projects Editor ones are making moves away from limited part- Graeme Kerr, Tel: +44 203 862 7491 [email protected] nerships? Without wishing to beg the question: Editor, Private Equity International yes, it is. Isobel Markham, Tel: +1 646 380 6194 [email protected] We live in a world in which some of the world’s This is now the seventh year that we have Reporters Rod James, Tel: +44 207 566 5453 biggest and most influential limited partners gone out to institutional investors to gather [email protected] have made noise about being less “limited” in views on everything from due diligence to asset Alex Lynn, Tel: +44 207 566 5463 [email protected] their approach to private equity. allocation. The Private Equity International LP

Carmela Mendoza, Tel: +852 2153 3148 Some investors reach a point at which they Perspectives Survey is one of the most in-depth [email protected] decide to take a mature private equity pro- and wide-ranging assessments of investor senti- Contributors Claire Coe Smith Muhammad Obaid gramme and start shifting it in-house: making ment in private capital markets today. Sophie Colby Emmanuel Osondu Marine Cole Victoria Robson principal investments rather than outsourcing The survey shows the perception that LPs Sheikh Jahan Craig Savitzky Rob Kotecki Stephen Schultz deal-making to general partners. Others have are paring back the number of relationships in Raymond Lau Matthew Xia Adam Le Chin Yuen decided to concentrate their programmes on their portfolio is just that: perception. Most LPs Vicky Meek a smaller number of external relationships, (53 percent) want to increase their number Managing Editor – Production Mike Simlett, Tel: +44 20 7566 5457 giving them – in theory – greater leverage to of manager relationships, 30 percent want to [email protected] negotiate terms. maintain the same number while 11 percent Head of Design Miriam Vysna, Tel: +44 20 7566 5433 The rationale for both approaches has the want to decrease it. One-in-three LPs plans [email protected] cost of investing at its heart. An institution that to increase its target allocation to PE in the Head of Marketing Solutions Alistair Robinson invests directly off its own back is not subject next 12 months and most investors (92 per- Tel: +44 20 7566 5454 [email protected] to the management fee-carry combination cent) believe their PE allocation will meet or Subscriptions and Reprints that GPs require. It can also hold companies exceed its benchmark in the next 12 months. Andre Anderson, +1 646 545 6296 [email protected] indefinitely, potentially eliminating the transac- The LP community is becoming more relevant Avinash Mair, +44 207 566 5428 tion costs associated with an asset that needs than ever. [email protected] to be bought and sold every few years, as the The following pages are crammed full of Sigi Fung, +852 2153 3140 [email protected] 10-year fund cycle demands. An investor which data; I’d like to thank our research team for For subscription information visit www.privateequityinternational.com. consolidates external manager programmes to their efforts in gathering it. I believe it is a valu-

Director, Digital Product Development fewer, deeper relationships, should in theory able benchmarking resource for anyone start- Amanda Janis, Tel: +44 207 566 4270 [email protected] be able to negotiate lower fees and reduce ing or maintaining a private equity programme.

Editorial Director the administrative costs of maintaining a vast And for GPs, I hope it gives an insight into Philip Borel, Tel: +44 207 566 5434 [email protected] number of fund holdings. what your investor base is currently thinking.

Director of Research & Analytics It is not all about costs. In conversation with Dan Gunner, [email protected] one longstanding (and publicity shy – hence my Head of Investor Research Nicole Douglas, [email protected] not naming them) investor in private equity, Enjoy the supplement,

Publishing Director they explained the ongoing process to grow Paul McLean, [email protected] their principal investment capabilities at the Chief Executive Tim McLoughlin, [email protected] expense of their fund investment programme Managing Director — Americas was about control. To paraphrase: in the last Toby Mitchenall Colm Gilmore, [email protected] downturn, they felt some funds were encour- Managing Director — Asia e: [email protected] Chris Petersen, [email protected] aged by certain LPs not to invest at what would december 2018/january 2019 perspectives 2019 1 CONTENTS PERSPECTIVES 2019

SURVEY RESULTS good thing, says Scott Dahnke, global 42 On the minds of top LPs co-chief executive officer at L Catterton From stressed portfolios to ESG, 18 PE in the portfolio investors tell us the issues that keep Private equity is outperforming 17 LP view: Achmea them awake at night investors’ benchmarks, The asset manager is planning to encouraging them to increase their increase its PE exposure to up to 5% 44 Keynote interview: MVision allocations of its more than €130bn portfolio MVision’s CEO Mounir Guen talks huge fundraises, new pools of capital and the 25 GP relationships 22 Keynote interview: Ardian value opportunities from Brexit Investors are looking to expand Investment solutions tailored to their GP portfolios as access to an investor’s needs are gaining in 48 Keynote interview: funds becomes more competitive popularity, say Ardian’s Martin Kessi BRG Asset Management and Krista Oertle The secondaries market is an efficient 32 Secondaries way to restructure maturing funds, Expect another year of healthy 28 LP view: Future Fund but managers and LPs may need to trading in the market for second- High prices for assets is making consider other options, say Finbarr hand fund stakes private equity less appealing, O’Connor and Gavin Farrell of BRG’s according to the SWF’s head of Alternative Investment Advisory group 38 Co-investments private equity Steve Byrom Arrangements between LPs and 50 LP view: Texas Municipal GPs don’t all fit the same mould 30 Keynote interview: eFront Retirement System Investors want more information Identifying the good managers is 46 Fund terms about where their money is going the easy part – the challenge comes Fees remain a bone of contention and that is putting a strain on fund in securing consistent access at for LPs, as fund sizes continue to managers. GPs can gain a competitive scale, says director of private equity grow advantage from managing these Christopher Schelling requests effectively, says eFront CEO 55 ESG Tarek Chouman 52 Keynote interview: Partners Group Only one third of LPs describe ESG Impact investment is on the rise, with as a major consideration, but that 34 Keynote interview: Evercore the increased involvement of more doesn’t tell the full story Armed with the most recent data, Nigel mainstream players in this part of the Dawn, senior managing director at market. Partners Group’s Kevin Lu Evercore, reflects on the growth of the discusses how their entry is changing 4 Seven LP perspectives that matter secondary market, what has surprised the market Here are seven charts that tell us what him the most in its evolution and where investors think of today’s major talking he sees it heading in the next decade 56 Keynote interview: SANNE points Given the wave of takeover activity 36 LP view: Willett Advisors among fund administrators, we sat 10 How we conducted our LP survey The CEO shares his thoughts on the down with Jason Bingham of SANNE US economy to discuss what it means for GPs 12 LP view: South Dakota shopping for service providers and The pension manager is slowing its 40 Keynote interview: the future of his industry deployment to private equity and Debevoise & Plimpton other equity-like assets to cut risk Today almost every GP is obliged to 59 Gender inequality in the crosshairs provide at least some co-investment Under-representation of women can 14 Keynote interview: L Catterton deals to investors. Debevoise & have serious consequences in PE LPs are more focused than ever on Plimpton’s Katherine Ashton outlines operational capabilities — and that’s a the issues at stake 60 From the mouths of LPs

NEW YORK Private Equity International is published © PEI 2018 be aware that external contributors 130 West 42nd Street, Suite 450 10 times a year by PEI. may represent firms that may have New York, NY 10036 No statement in this magazine is to an interest in companies and/or +1 212 633 1919 To find out more about PEI please visit: be construed as a recommendation their securities mentioned in their Fax: +1 212 633 2904 www.thisisPEI.com to buy or sell securities. Neither this contributions herein. publication nor any part of it may LONDON PRINTED BY: Stephens & George Ltd. be reproduced or transmitted in any Cancellation policy: you can 100 Wood Street www.stephensandgeorge.co.uk form or by any means, electronic or cancel your subscription at any London EC2V 7AN mechanical, including photocopying, time during the first three months +44 20 7566 5444 recording, or by any information of subscribing and you will receive Fax: +44 20 7566 5455 storage or retrieval system, without a refund of 70 percent of the total HONG KONG the prior permission of the publisher. annual subscription fee. Thereafter, no 19F On Hing Building Whilst every effort has been made to refund is available. Any cancellation 1 On Hing Terrace ensure its accuracy, the publisher and request needs to be sent in writing Central, Hong Kong contributors accept no responsibility [fax, mail or email] to the subscriptions +852 2153 3240 for the accuracy of the content in departments in either our London or Fax: +852 2110 0372 this magazine. Readers should also New York offices.

2 private equity international december 2018/january 2019 $27 billion raised and advised on by MVision in the last 12 months

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INTRODUCTION Seven LP perspectives that matter

Private Equity International’s Perspectives is one of the most comprehensive surveys of the private equity investor universe. Here are the charts that tell us what LPs think of today’s major talking points. By Toby Mitchenall

4 private equity international december 2018/january 2019 HIGH FEES ARE A TOUGH SELL To what extent do you agree A 10-year bull run in public markets is a that fees charged by private mixed blessing for private equity. Yes, rising equity funds are difficult to justify valuations make for an exciting market to internally: sell businesses into, but the relative perfor- mance of the wider stock market – which 2.4%

is easily accessed through low cost track- 34.5% 16.7% ers – can make private equity seem like a needlessly expensive option for an asset allocator. Earlier this year, Pennsylvania state treasurer Joe Torsella claimed the two state pension systems had “wasted” up to $5.5 billion in investment expenses and would have been better served by low-cost passive funds. This simple comparison of the last 10 years ignores some important factors, 46.4% Strongly agree most notably the relative outperformance Agree of private equity over the full market cycle. Disagree Even so, our survey suggests Torsella is Strongly disagree not alone in his late-cycle misgivings: 61 Source: Private Equity International percent of limited partners said they either agree or strongly agree with the statement GPs are increasingly instigating that “the fees charged by private equity restructuring processes on old funds are difficult to justify internally”. funds in order to move assets into a new vehicle. In these RESTRUCTURING COSTS DISPUTED circumstances, do you believe the Our survey reports that most LPs (57 per- costs of the process were fairly cent) have had a fund restructuring – where divided between the GP and the assets are moved from an existing vehicle to fund?

a new one with new terms – proposed by at 22.0%

least one of their GPs. In the last two years 42.7% a number of storied firms have run such processes on their funds, such as Nordic Capital, InvestIndustrial and – ongoing as this publication goes to press – TH Lee. These are complex transactions and often divide opinion among an investor base. Per our survey, more than a third of LPs who have been involved in such a proposal said they did not have sufficient time to make 35.4% Yes a decision, while a similar proportion said No they had insufficient information. Have not been party to a restructuring While this may seem alarming, it ›› Source: Private Equity International december 2018/january 2019 perspectives 2019 5 PERSPECTIVES 2019 | OVERVIEW

Which of the following best How significant a part do the following play in due diligence? describes your assessment of GP investment behaviour in the last GP performance track record 97.6

12 months? GP team size and investment capacity 91.6 8.4

Investment thesis and style drift 89.0 9.8 1.2% 8.3% Firm “culture” at the GP level 61.0 39.0

Fund structural review 60.2 39.8

Succession planning and retention 57.8 41.0 plans at the GP level Fee validation 52.4 45.1

GP balance sheet/financial strength 19.3 66.3 14.5

Gender pay gap at GP level 38.6 56.6

35.7% 0 20 40 60 80 100 Percentage of respondents

54.8% Forms a major part of the process Forms a minor part of the process Not covered in due diligence

Source: Private Equity International

I see occasional examples of “style drift” among my GPs ›› is to some extent expected. We have PEI reported distributions have outpaced

GPs are remaining disciplined and sticking frequently heard a significant minority of capital calls for five years, and the gap to their investment thesis LPs do not have the bandwidth to assess between the two was widening. “If manag- I see widespread examples of “style drift” these deals within the timeframes. More ers are keeping an eye on pricing relative among my GPs divisive is the cost allocation of such a deal: to public markets and other M&A transac- Other nearly two-thirds of LPs said the costs of tions, and decide to slow down on this basis, Source: Private Equity International the process were not fairly divided between then I am more comfortable with a slower the GP and the fund. investment pace,” Angela Willetts, co-head of private equity at Capital Dynamics, told I SEE STYLE DRIFT PEI in August. Two words no one in private equity wants to hear: “style drift”. It can take many differ- GENDER AS AGENDA ITEM ent forms: investing in an unknown sector, Diversity and inclusion is an emerg- a new geography, moving from majority to ing factor among limited partners when minority stakes, buying public stocks; or selecting a manager. While the “staples” buying larger (or smaller) companies. It of due diligence – track record, team size tends to be a topic of conversation at the and investment thesis – remain the cen- height of a market, when competition for tral tenets of nearly all LPs’ due diligence, assets pushes managers to get creative: 55 a portion – 43 percent – are including percent of LPs report seeing “occasional gender pay disparity at the GP as part of examples of style drift” among their GPs, their due diligence process. We fully expect while 8 percent reported seeing “wide- this percentage to increase in the coming spread examples”. Just over a third said GPs years. Lobby group ILPA is now including were “remaining disciplined and sticking to gender and ethnic diversity in its due dili- their investment theses”. gence template. Said Andrea Auerbach, head Should we be alarmed by this find- of private markets at LP advisor Cambridge ing? Other data suggest GPs are slowing Associates: “If [some of our clients] don’t see their investment pace, rather than drift- sufficient levels of diversity and inclusion, or ing beyond their remit. In August 2018, well-intentioned and meaningful efforts ››

6 private equity international december 2018/january 2019

PERSPECTIVES 2019 | OVERVIEW

›› to build towards a team and organisa- Do you plan on investing in 11.6% tion that has more diversity of personnel, co-investment opportunities they will make an investment decision fully in private equity over the incorporating that information.” next 12 months? CO-INVESTMENT STAMPEDE It is a popular way to cut fees when invest- ing in private equity, which is why, accord- Yes No 23.3% ing to our survey, 65 percent of limited Unsure partners intend to deploy capital through 65.1% co-investments in the next 12 months. Source: Private Equity International Widespread co-investment is a relatively new feature of private equity investing. “I Thinking of your fundraises in the last 12 months that you expressed don’t think we’ve been through a whole interest in, which of the following describes your experience? cycle yet with co-investments and there are certainly some challenges there,” said

We have consistently received our full Per Olofsson, head of alternatives at AP7. requested allocation in our chosen funds 59.8 GP POWER We have had our allocation scaled back in most of our chosen funds due to 28.0 The received wisdom in private equity is excess demand that rampant demand from LPs has put

We have had our allocation scaled back GPs in a position of firm negotiating power 3.7 in some of our chosen funds in fundraising; take our terms or we will easily replace you in our investor base. One We have been unable to secure 3.7 allocations in most of our chosen funds data point from our survey suggests the situation may be more balanced. Most LPs Have not made any new commitments in the last 12 months 2.4 (60 percent) told us they have consistently received the full allocation in their chosen

Other 2.4 funds, whereas only 28 percent had seen their allocations scaled back in some of their 0 10 20 30 40 50 60 chosen funds. Rather than pare LPs commit- Percentage of respondents ments back, it is likely GPs are simply raising Source: Private Equity International bigger – or additional – funds.

Which of the following ASIA ON MY MIND 80 emerging market 84.1 Asian PE has come of age and global inves- geographies will you 70 tors are arriving in droves. The region’s GDP consider for investment 60 growth and rising middle classes, combined over the next 12 50 with the growth of “institutional-grade” gen- 40 months? Please select 39.0 eral partners is proving a draw; a number of US all that apply. 30 31.7 public pensions are growing their exposure.

20 17.1 “In the past five years, nearly 40 percent

Percentage of respondents Percentage 13.4 10 of our global private equity commitments

0 have been to managers focused on the Asian Asia-Pacific Central/ Latin Middle East Sub-Saharan Eastern America and North Africa region,” said Art Wang, managing director, Europe Africa private markets at San Francisco Employees’ Source: Private Equity International Retirement System. n

8 private equity international december 2018/january 2019

PERSPECTIVES 2019 | METHODOLOGY

How we conducted our LP survey

Now in its seventh year, the LP Perspectives Survey is Private Equity International’s annual In which region is your institution What is your average fund study of institutional investors’ approach to headquartered? commitment size for the following alternative asset classes. It aims to provide asset classes? 2% a granular view of the alternatives market, 1% both current and future, by gathering insight 5% on investors’ asset allocation, propensity to invest and performance predictions. 19% $100.15m Perspectives is a global study, reflected Private real estate in the question set and the respondents, which allows for meaningful global views and cross-regional comparisons across alternative asset classes. The question set $65.75m for Perspectives is reviewed annually, with the Private equity objective of reflecting market developments $67.02m and shifts in sentiment. 29% 45% Private debt For the 2019 study, PEI’s Research &

Analytics team surveyed 101 institutional Western Europe investors across private equity, private real North America estate, infrastructure and private debt. Asia-Pacific $73.31m Middle East/Africa Infrastructure Fieldwork was carried out from August to Latin America October 2018. Participation in Perspectives is Central/Eastern Europe anonymous, with the findings amalgamated and presented in this supplement. n Source: Private Equity International Source: Private Equity International

What type of institution are you?

19.3

14.5 14.5 14.5 13.3

10.8

4.8 Percentage of respondents Percentage

2.4 2.4 2.4 1.2

Public pension Fund of funds Private pension Bank/financial Family office or Insurance Corporate Consultant Sovereign Endowment or Other fund fund services high-net-worth company wealth fund foundation individual

Source: Private Equity International

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PUBLIC PENSIONS Why ‘contrarian’ South Dakota is bearish on PE

The $14.8bn pension manager is slowing its deployment to private equity and other equity-like assets to cut risk, writes Alex Lynn

South Dakota Investment Council is, by its own admission, unlike any other US public pension. At a time when many institutional investors are piling capital into private equity, the Sioux Falls-based fund is doing the opposite. SDIC manages $14.8 billion in assets across six funds, including the $12.2 billion South Dakota Retirement System and the $1.2 billion South Dakota Cash Flow Fund. The Federal prospects for a time, well then we pull back. The pension has as much as 9 percent Reserve and If we’re right then there’ll be disappoint- exposure to private equity but is slowing ment experienced by those involved, and its deployment to the asset class and other other monetary then opportunities will re-emerge and we’ll equity-like assets as part of its “contrar- authorities around the be back.” ian” investment strategy, state investment world are creating these officer Matt Clark tells Private Equity Inter- RISKY BUSINESS national. bubbles to push things Clark’s bearishness is not based on gut “It was around 7 percent a decade or to bigger extremes on instinct; the loss of appetite comes from a so ago and then it went up after the crisis the overvalued side than formula SDIC uses to assess investments. It because there were a lot of opportunities,” gauges the fair value of potential assets by he says. “And that’s been slowly working its we’ve historically seen estimating future cashflows of these invest- way back down.” Matt Clark ments and comparing that to the price. Silver Lake, Blackstone and Cinven In a neutral risk environment around accounted for the largest pools of assets 70 percent of SDIC’s portfolio would be within SDRS’s $782 million private equity “The wall of commitments out there held in what it considers to be risky assets, portfolio as of June 2017, according to is competition for underlying deals, and such as stocks, private equity or real estate, its latest annual report. The portfolio also the more money in private equity chasing with the remainder in bonds, Clark says. includes commitments to KKR, Carlyle a given number of deals, the more bid up If prices are well above its appraised fair Group and CVC Capital Partners, each of the prices get and the less the return pros- value measures then it cuts risk to around which has raised a mega-fund over the past pects are,” Clark says. 50 percent, with the remainder going into two years. “When those conditions suggest poor either investment-grade bonds or cash.

12 private equity international december 2018/january 2019 Though the strategy provides some pro- South Dakota is unlikely to remain a bit- SDRS AT A GLANCE tection from market headwinds, it can also part player in private equity forever. PE accounted for only a small mute short-term performance. SDRS – the “The Federal Reserve and other mon- proportion of SDRS's $11.6bn largest of SDIC’s funds – had an estimated etary authorities around the world are creat- portfolio as of 30 June 2017 1.1 percent net return for the fiscal year- ing these bubbles to push things to bigger to-date as of 31 July. extremes on the overvalued side than we’ve 6.7% 1.0% The long-term rewards, however, are historically seen,” Clark adds. “That then 9.3% clear: South Dakota had the third-lowest leads to some kind of bubble that ultimately pension liabilities shortfall of any US state gets pricked and creates a crisis where it

13.7% as of December, behind only Vermont and overshoots on the other side, [which] just North Dakota, according to research from creates huge opportunities.” the American Legislative Exchange Council. And while the heady fundraising envi- “Right now as minimum risk exposure ronment has left some LPs struggling to in the markets keeps going up we’ll be suf- secure their desired commitment size, or fering on a relative performance basis, and in some cases even a place in the vehicle, that pain will discourage imitators espe- Clark is not concerned about losing out in 20.7% 48.6% cially when they haven’t tasted the rewards future as a result of neglecting important in the past,” Clark notes. GP relationships. Global equity Fixed income & high-yield debt “It’s kind of a chicken and the egg thing “I would think that partners of ours Cash & cash equivalents on that. It’s hard to start off being a con- would appreciate the fact that we show up Real estate trarian if you think you’re going to get when they need us most, which is when Private equity Aggressive absolute return fired after the first wrong call. Therefore things are bad and others are making you never take that first bold step and you excuses and they’re struggling to have much Source: SDIC never build up a track record.” of a fund,” he says. n december 2018/january 2019 perspectives 2019 13

KEYNOTE INTERVIEW: L CATTERTON

OPERATING PERFORMANCE ‘LPs are asking more about operational value creation’

LPs are more focused For private equity firms, one of the most from an operational perspective. than ever on operational gratifying aspects of the PEI LP Perspectives We tend not to use as much financial Survey is just how supportive investors are of leverage as most others in the space, which capabilities — and that’s the way that GPs are investing their funds. means that our equity has to work harder. a good thing, says Of the LPs surveyed, 69 percent say they Better operating performance is therefore Scott Dahnke, global think that GPs have allocated capital at an key to our ability to drive high risk-adjusted co-chief executive officer “appropriate rate” in the last 12 months, returns. Historically, roughly 80 percent of at L Catterton and when asked about “style drift”, more our value creation has been of an opera- than one-third of LPs say GPs are remaining tional nature. disciplined and sticking to their investment thesis, and, of the rest, 55 percent saw just Karen Gordon: Our operating approach occasional style drift. is highly replicable deal after deal, fund Either way, LPs are more focused than after fund, and we’re very proud of what ever on how GPs can add real and meas- we have built. We do our research and urable “alpha” to their portfolios, and as a assess the value with respect to the exe- result, are increasingly focused on how GPs cution risk. Our operational team brings drive operational success, say Scott Dahnke, relevant expertise in specialised operating global co-chief executive officer at L Catter- disciplines, such as digital marketing, pro- ton, and Karen Gordon, managing partner curement and Six Sigma. The fact that the of portfolio operations at L Catterton. economy has been strong means there is more pressure on operating returns and What do LPs want to know about more focus by LPs on operating returns. operational value creation and how That is all good from our perspective. do you address the topic with investors? Scott Dahnke: In today’s environment, with Could you describe your operational record levels of dry powder and significant value creation process? access to relatively inexpensive financial SD: We’re category-first investors. We leverage, LPs are increasingly seeking to identify categories to target for invest- understand the drivers of performance that ment based on identifiable consumer will be consistent over time, regardless of trends and then develop an investment the prevailing economic conditions. thesis in those categories based on how We’re seeing LPs engaging more with we see competitive dynamics, consumer GPs and portfolio companies, and asking trends, and other forces playing out. We for more data to understand the sources of then partner with management and deploy the returns. Increasingly, LPs are looking for our own resources to help the company specific drivers of operational value crea- execute that plan. tion in addition to how much of that return is being driven by earnings growth vs. mul- KG: This helps us to identify specific com- tiple expansion and/or debt paydown. As an panies, and once we build a relationship

Dahnke: 80 percent of our value creation is operationally focused GP, we love it when with them we can jointly develop a value- operational LPs are asking more about value creation creation thesis that’s right for that business,

14 private equity international december 2018/january 2019 KEYNOTEKEYNOTE INTERVIEW: INTERVIEW: L CATTERTON J-STAR

in that sector, that reflects current and pro- PREMIUM PETS jected consumer behaviour. When L Catterton invested in fifth-generation family- owned pet food manufacturer Ainsworth Pet Nutrition SD: At L Catterton, our operating and deal in May 2014, the consumer growth firm already had a teams work together seamlessly to identify deep knowledge of the pet products and natural pet food categories, develop an investment thesis in space. L Catterton sold Ainsworth to JM Smucker for these categories, and conduct diligence for $1.9 billion in April 2018. Earnings increased by more targeted portfolio opportunities. It’s two than 10- fold and on an unlevered basis L Catterton real- halves of the same brain. ized an 8x multiple to invested capital during the four- year hold. Ainsworth organically tripled its market share How do you approach management during the period. For their success with Ainsworth, PEI teams? awarded L Catterton the 2018 Operational Excellence Quality counts: L Catterton SD: Our first interaction is rarely about a Award for the Upper Mid-Market in the Americas. This saw an opening for premium potential transaction. Most of the time, our dog food marked the second-time that L Catterton has garnered first interaction is with a founder or C-level the award, having won in 2014 for their successful exit of Restoration Hardware. executive and starts with a conversation about the dynamics within the category that What did you see in Ainsworth? the business operates. We share data from SD: We have watched the dynamics and tracked consumer trends within the pet our research and insight from our experi- food category over multiple decades – again, we do our homework. With Ainsworth, one ence which helps entrepreneurs understand of the opportunities we saw was to bring super premium pet-store quality products that we have value to contribute that can to food, drug and mass retailers and grow that in partnership with these retailers. In supplement what they already have in the short, “pet store quality, supermarket easy”. organisation. Our detailed category work and research is a key differentiator. ›› What was your focus once the company was purchased? SD: We wanted to build the Nutrish brand in the food, drug, and mass market area. That focus led us, in partnership with management, to refocus and align virtually all assets of the business on Nutrish, from marketing and brand building, to product innova- tion, distribution, and retail strategies, all the way through to operations and operational efficiency. We increased consumer advertising spending in the business almost 10-fold in a period of four years. We worked with the company to write the first TV ad, which was award-winning. By the time we exited the business, we had invested more than $50 million in television advertising and social and digital advertising in support of the Nutrish brand. LPs are increasingly Do you see other opportunities in the pet food space? SD: Absolutely. The pet food business is exceptionally large, and consumer driv- seeking to ers remain strong. We have other investments in the pet space, both domestically and understand the drivers of internationally, including Lily’s Kitchen, Just Food For Dogs, Canidae, and others. All performance that will be these investments capitalise on our knowledge of these trends but in slightly different ways. We are also targeting a number of new investments in the space. consistent over time Scott Dahnke december 2018/january 2019 perspectives 2019 15

KEYNOTE INTERVIEW: L CATTERTON

Can you describe the methodology that proprietary edge helps us source deals you use once you’ve made an invest- that fit our skills. Given the competitive ment? dynamic in the private equity space, found- KG: We believe we have a particularly ers and CEOs are increasingly asking what powerful framework. We have a consistent an investor offers beyond capital. Having the approach to collaboration, to issue identi- ability to bring case studies and relevant fication, to prioritisation, and a philosophy value creation examples to bear is power- for how and where we deploy resources to ful in winning investment opportunities. drive higher levels of value creation. Further, our sector-specific expertise has The first step is to develop a value crea- helped cultivate a well-developed global tion thesis very early in the diligence pro- network of industry relationships. There are cess. This ensures our team is aligned with myriad benefits from being a sector-focused management from the outset. Immediately fund and from having been a sector-focused upon deal closing, and sometimes earlier, we fund for 30 years. We can’t imagine it any work together to get very specific about the other way. initiatives that we want to drive, how those The fact that initiatives translate into value creation, what What do you expect in 2019 for the resources are required, and what milestones the economy economy and private equity and can we should measure our progress against. We has been strong you explain how that may impact your have a disciplined approach to creating KPIs means there is more investment thesis? that gives us visibility into the performance pressure on operating SD: We’re now 10 years into a five- to of the business overall. seven-year economic cycle, so every invest- This also allows us to project perfor- returns ment we make today is one in which we mance so we can respond to what is happen- Karen Gordon forecast a recession within the hold period ing, predict what will happen, and plan for of that investment. That doesn’t mean that it proactively. At times, we will also dedicate we necessarily think a recession will happen our own internal team resources to drive in 2019 or in any specific time frame, but certain initiatives and support their delivery. we would forecast some sort of pullback in the next few years. This impacts our SD: We’re investing in growth businesses underwriting, our capital structures, and across the consumer sector. At a high level, our value creation plans. the drivers of value creation are similar We really do our homework and that’s a across many of these companies, however differentiator for us. Many of us including the approach required to achieve the value Karen and me have backgrounds at places is always bespoke. From that perspective, such as McKinsey, BCG and Bain and know metaphorically, we are not walking around the value of data and research. As it relates with a hammer looking for a nail – we have to our investment focus, we are targeting developed a broad tool kit that enables us to areas where consumers are likely to con- deploy the right tools for the job, in part- tinue to spend and prioritise. These are nership with portfolio company leadership. driven by secular and demographic trends, technological trends, geographic trends and How much does being a sector- socio-economic trends. While we expect focused fund help you with opera- that there may be some slowdown, we’re tional value add? confident that if we pick a well-positioned SD: CEOs, boards, and even investment company in an attractive and on-trend cat- bankers are increasingly aware of our opera- egory and apply our unique capabilities, the tional success in the consumer arena, and investment will still do well. n

16 private equity international december 2018/january 2019 PERSPECTIVES 2019 | LP VIEW

ACHMEA ‘We see the first signs of trouble’

The Dutch asset manager is planning to increase its and type of investment such as buyouts, private equity exposure, but is taking nothing for growth and special opportunities. The US granted, writes Carmela Mendoza makes up about 45 percent of its portfolio; EU, 45 percent; and the rest of the world, 10 percent. Dutch investment firm Achmea Investment There’s too Its portfolio of alternative assets also Management is considering increasing its includes hedge funds, infrastructure, real strategic exposure to private equity to 5 much money for estate and commodities. The value of this percent of its total portfolio in the next too few deals. portfolio as of August 2018 is approximately few years. On the surface the returns €13 billion. The share of alternative invest- “We are in the build-up phase, the group ments in the overall portfolio has, however, is light in private equity exposure and we are fantastic, but if the decreased due to reductions in its positions are building up the programme,” senior underlying companies in commodities and infrastructure, Achmea portfolio manager Jos van Gisbergen tells are not growing, people notes in its latest annual report. Private Equity International. “It’s challenging to time the market, so if there’s not any will realise that’s just lot WHAT GOES UP… good offering or any great fund that fits of air in it Van Gisbergen says private equity investors our criteria, we won’t do it. Quality and Jos van Gisbergen expect returns to inevitably come down alignment goes first since private equity is because the fundamentals of the market a long-term asset category.” are changing. Achmea’s strategic target allocation to “We already see the first signs of trou- the asset class is 60-80 percent in funds, ble coming – a rising interest environment 10-20 percent in co-investments and 10-20 combined with high leverage, will make it percent in secondaries, he adds. more difficult to make good returns. It’s also Along with investing in high-quality a highly competitive market where people managers, van Gisbergen also notes the are buying at crazy multiples, at 10-12x firm is “keen on backing European spin- EBITDA whereas the average historic has outs because they know how the system and been around 8x. It’s almost impossible to processes work and have a good network”. make great returns as we saw in the past. At The investor has backed funds managed expectations of 5 percent for public equity by LeapFrog Investments and Life Sciences and 3 percent for illiquidity premium, one Partners, according to PEI data. should expect returns of between 8 percent Achmea serves as asset manager for 35 and 12 percent as being more realistic.” pension funds and insurance companies in Van Gisbergen also warns of private the Netherlands and manages more than equity’s “massive inventory pool”, which he €130 billion in assets, according to its explains as GPs circulating assets among website. themselves instead of selling to strategic The firm’s private equity exposure investors or listing in the public markets. stands at less than 1 percent or about €1 “There’s too much money for too few billion, including outstanding commit- <1% deals. On the surface the returns are fan- ments, van Gisbergen says. The private Achmea’s current private tastic, but if the underlying companies are equity investments are highly diversified equity exposure not growing, people will realise that’s just in terms of sector, geographical region lot of air in it.” n december 2018/january 2019 perspectives 2019 17 PERSPECTIVES 2019 | SURVEY RESULTS: PE IN THE PORTFOLIO

ASSET ALLOCATION A virtuous circle Private equity is outperforming investors’ benchmarks, encouraging them to increase their allocations to the asset class, writes Isobel Markham

Investors want greater private equity expo- sure in their portfolios. Please indicate your current allocation position for the following asset One in five respondents to the PEI LP classes: Perspectives Survey 2019 indicated they are 57.6 underallocated to the asset class, and there are several contributing factors. Strong performance in recent years has driven 37.9 34.7 36.2 investors to gradually ratchet up their 31.6 27.7 allocations, leading to a perpetual state of 26.3 22.2 23.2 22.3 “catching up” with their own targets. 18.9

Added to this, private equity distribu- 11.1 10.6

Percentage respondents Percentage 9.5 7.4 5.1 5.3 5.3 tions have outweighed capital calls for the 4.0 3.2 past five years, according to data from pri- vate equity software provider eFront. In Private equity Private real estate Infrastructure Private debt fact, in the last quarter of 2017, LPs had Over allocated Invest opportunistically (no set allocation) an average of 1.2 percent of their commit- At target allocation Do not invest Under allocated ted capital to a given fund called, versus distributions of 3.5 percent. Source: Private Equity International “Distributions back to investors have continued to be incredibly robust, and as How has private equity performed How do you feel private equity will a result, investors are having to turn right against its benchmark over the perform against its benchmark in around and put money back to work,” says past 12 months? the next 12 months? Andrea Auerbach, global head of private investments at Cambridge Associates. This “indigestion of success” is a challenge for 8.7% 8.5% many LPs. 52.2% 41.5% This is compounded by strong perfor- mance of public equities portfolios lead- ing to a “reverse denominator effect” – a bloated equities component squeezing the same dollar-value of private equity invest- ments into a smaller proportion of the overall investment portfolio.

Private equity has been performing well 39.1% 50.0% for our survey respondents; more than half of investors indicated private equity had Exceeded benchmark Will exceed benchmark outperformed their benchmark for the asset Met benchmark Will meet benchmark class, while just 9 percent said the asset class Fell below benchmark Will fall below benchmark fell below their benchmark. Source: Private Equity International Source: Private Equity International

18 private equity international december 2018/january 2019 How do you plan to change the target allocation to the following asset classes over the next 12 months?

64.9 63.3 60.7 59.3

32.0 28.6 27.0 21.1 15.6 Percentage respondents Percentage 12.4 12.1

3.1

Private equity Private real estate Infrastructure Private debt

Increase target allocation Keep target allocation the same Decrease target allocation

Source: Private Equity International

Regarding private equity, how do you plan on allocating to the following strategies over the next 12 months?

77.1

67.0 67.4 61.4 57.6

36.5

29.2 25.3 23.9

14.8

Percentage respondents Percentage 14.5 8.4 7.7 5.9 3.4

Buyout Distressed Fund of Funds Growth Venture Capital

Increase target allocation Keep target allocation the same Decrease target allocation

Source: Private Equity International

And they have high expectations for the delivered a 14 percent return, versus a 12 next 12 months, with 41 percent expect- percent return and an 11 percent return ing the asset class will exceed the bench- for the S&P 500 and the Russell 2000, mark and 50 percent that it will meet the respectively. benchmark. Investors are most optimistic “Not that you can buy the market in about private equity’s ability to exceed the private equity, but even if you did buy the benchmark versus other asset classes. market, you would still be outperforming Over a three-year period, the Cam- your public market options,” Auerbach bridge Associates Private Equity Index says. “The return dispersion in private ›› december 2018/january 2019 perspectives 2019 19 PERSPECTIVES 2019 | SURVEY RESULTS: PE IN THE PORTFOLIO

›› markets is immense, so if you’ve done a decent job of manager selection you should Thinking of your private markets portfolio, which three factors will have be significantly outperforming those public the greatest impact on performance over the next 12 months? market benchmarks.” Thanks to this strong performance, Extreme market valuations 66.3 around a third of respondents intend to Rising interest rates 56.1 increase their target allocations to private US/China trade war 33.7 equity in the next 12 months, more than Access to top-choice PE funds 32.7 Availability of leverage in alternative the other asset classes; just 3 percent expect 19.4 investment markets to decrease their allocation. The most out- Fee levels 18.4 of-favour asset class appears to be private Foreign exchange rates 18.4 real estate, with 21 percent expecting to Commodity price volatility 12.2 decrease their allocation over the next 12 Impact of the UK’s exit from 9.2 months. the European Union Within the private equity bucket, LPs Natural disasters 4.1 are most excited about growth strategies; Cybersecurity threat 3.1 29 percent are looking to increase their target allocation. And investors could be Percentage of respondents on to a winner here: analysis by Cambridge Source: Private Equity International Associates found that half of companies that grew revenue 20 percent or more while Which of the following best Which of the following best under ownership were sold for a 3x mul- describes your assessment of GP describes the rate of capital tiple or better. investment behaviour in the last deployment by your GPs over the “Growth is scarce. In any market envi- 12 months? past 12 months? ronment, companies will pay for growth,”

Auerbach says. 1.2% 3.6% 1.2% In terms of emerging markets, nearly 8.3% 10.7% 85 percent of respondents are consider- ing Asia-Pacific for investment in the next 12 months. Excitement for the region has been palpable over the last few years, with prominent LPs such as the California State Teachers’ Retirement System affirming their intentions to commit more capital 35.7% there. 54.8% 15.5% 69.0% Underlying reasons for the increased appetite include the region’s GDP growth I see occasional examples of “style drift” They have deployed capital at an appropriate rate among my GPs for this market rates of at least 6 percent, its rising middle GPs are remaining disciplined and sticking They have deployed capital too quickly class, and the growth opportunities and to their investment thesis They have not deployed capital quickly enough investment themes around disruption that I see widespread examples of “style drift” are expected to generate outsized returns, among my GPs Varies across GPs LP sources told Private Equity International Other Other in September. Source: Private Equity International Source: Private Equity International

20 private equity international december 2018/january 2019 Enthusiasm for private equity is, of Which of the following emerging market geographies will you consider course, tempered by a healthy dose of con- for investment over the next 12 months in the following alternative asset cern. Respondents indicated that extreme classes? Please select all that apply. market valuations are likely to have the greatest impact on performance over the

Asia-Pacific 84.1 next 12 months. Private equity sponsors paid on aver-

Central/Eastern Europe 39.0 age 14x EBITDA for US assets and 11x in Europe last year, according to data from

Latin America 31.7 S&P Global Market Intelligence, and 14.1x in Asia-Pacific, according to Bain & Co.

Middle East and North Africa 17.1 “The biggest [concern we’ve heard from LPs] is how you respond to the Sub-Saharan Africa 13.4 excess supply of buyout capital pushing up prices for assets; that’s the bit the LPs

Percentage of respondents are working hardest to understand,” says Source: Private Equity International Christiian Marriott, head of investor rela- tions at European buyout firm Equistone, On average, how many fund opportunities are presented to you per year? which closed its sixth flagship fund on €2.8 billion in March. 86.5 “In particular, they’re trying to get com- fortable with many GPs using higher lever- age on the basis that it’s being provided on 38.1 34.3 25.4 very sponsor-friendly terms, in terms of covenant headroom and equity cure rights.” Another indicator we are late in the Private equity Private real estate Private debt Infrastructure cycle for private equity are instances of Average number of fund opportunities “style drift” among LPs; 55 percent of Source: Private Equity International respondents said they see occasional exam- ples of this among their LPs, and a further Of those fund opportunities, what percentage reach the due diligence 8 percent consider it widespread. stage? (%) “We’re nine or 10 years into the cycle, so you have a lot of investment professionals

16.6 16.1 trying to put capital to work that haven’t 14.9 14.0 necessarily experienced volatility. Their awareness of the risks they’re taking may be dulled,” says Auerbach. This emboldens managers to extend their strategies into different sectors, Private equity Private debt Infrastructure Private real estate market segments and geographies.

Percentage of funds reaching due dilligence “Style-drift tends to occur right now,” Source: Private Equity International Auerbach adds. “It doesn’t occur when you’re in a trough.” n december 2018/january 2019 perspectives 2019 21

KEYNOTE INTERVIEW: ARDIAN

MANDATES LPs demand a more customised approach

Investment solutions Customised mandates, separate managed an established manager such as Ardian, who tailored to an investor’s accounts, funds of one – investment solu- can deliver a complete investment solution. tions tailored to an investor’s needs have We are also talking to investors, who tra- needs are gaining in many names and come in different forms, ditionally have not been the main target popularity, say Ardian’s but one thing is certain – their popularity segment for mandates. Private banks, for Martin Kessi and continues to increase. instance, are increasingly interested in Krista Oertle Ardian is well-known for its secondary finding solutions for their high-net-worth business, having made a number of land- individuals and how they can access an asset mark transactions over the past years. Less class that has been geared towards institu- in the headlines but growing just as strong is tional investors up to now. its mandate business. Martin Kessi, manag- Geographically, much of the demand ing director in the fund of funds team, and is coming from our traditional investor Krista Oertle, head of mandate solutions in regions, meaning Europe, North America Ardian’s Zurich office, tell us more. and Asia. However, the landscape is broad- ening. For instance, we just closed our first Are mandates a new business area Latin American mandate a little while ago, for Ardian? so it is becoming global for us. No, tailored mandates are not a new busi- ness for us. We have been doing this for What are investors looking for in over 20 years. Especially since the spinout mandates? of Ardian from AXA Group in 2013, we Lower fees are often thought to be the main have broadened our offering and added a reason for choosing a mandate over a fund number of new mandate clients. On the of funds commitment. While this is a very one hand, the overall investor demand in important aspect of the mandate offering, the market for customised portfolio solu- in our experience, other aspects matter just tions has grown significantly over the past as much. What investors generally seem to years, visible also in our growth rates. On look for is flexibility and something that the other hand, mandates are one of the meets their needs. This comes in various strategic focus areas of Ardian and as such, forms and can be fully delivered through a the results of our continuous efforts to tailored mandate solution. improve our services are yielding results. At Ardian, we tailor a mandate around each client’s organisation, investment needs Where is demand coming from? and preferred ways of collaboration. We We have long investor relationships combine funds across private market strat- with many pension funds, insurance compa- egies, segments and regions. For this, the nies and family offices so part of the demand large fund of funds platform that we have is coming through these existing relation- today is key, with around $5 billion on aver- ships. At the same time, new pension funds, age invested in primaries and secondaries insurers and family offices continue to enter an on annual basis. We offer discretionary the market and often prefer to partner with and non-discretionary mandates, giving

22 private equity international december 2018/january 2019 KEYNOTEKEYNOTE INTERVIEW: INTERVIEW: ARDIAN J-STAR

Going global: Ardian has just closed its first Latin American mandate investors the choice to decide how much All in all, the needs from the investor side The overall they want to be involved in their mandate. are complex and a mandate manager today Our investors define what is their invest- needs to be able to understand and adapt investor ment horizon and targets and when those to those needs. demand in the targets change, the mandate solution adapts. market for customised And on top of this our investors get the What is the role of secondaries in operational and reporting services they your mandates? portfolio solutions has need. We have mandates that do not have any grown significantly over secondaries and we have mandates in which the past years Do investors want to be involved in secondaries are a key allocation type. It their mandates? really depends on the investment targets Some, yes, to a varying degree. of the investor. If you as an investor know you do not Often if we put together a comprehen- have the resources to be involved in the sive portfolio solution for a client, particu- investment process and portfolio planning larly if the investor is new to private equity, and are looking for a reputable, trusted and secondaries have a significant role in partner to outsource your private market ramping up exposure, in addition to the allocation, you probably will opt for a dis- diversification benefits that they bring to a cretionary, hands-off solution. portfolio. You might see higher allocations But we do have mandate investors who to secondaries in the first one or two years. want to participate in the decisions on Naturally, this allocation tends to change where the assets are being invested, want over time, particularly when we are talk- to read the investment memos and have ing about mandates that invest over 10, 15 the final say and we can accommodate that. or 20 years. ›› december 2018/january 2019 perspectives 2019 23

KEYNOTE INTERVIEW: ARDIAN

Kessi: private banks are looking for solutions for Oertle: secondaries help diversify the portfolio HNW individuals

When does a mandate not make needs to have the right service package, in sense? addition to offering attractive fees and being We can recommend a mandate solution to able to demonstrate a good track record, all clients who want an individualised private just to make a difference between you as a market investment programme tailored to manager and your competitors. their needs. Due to the initial effort at the beginning of such a programme, mainly Do you see the growth in private with legal and operational setups, a man- infrastructure in mandates? date is generally worthwhile only from a Infrastructure is becoming more and more certain volume. The cost savings in relation important for our investors. We already have to management fee must compensate for mandates which are focused on infrastruc- these initial fixed costs. ture. And we have mandates which invest across private market strategies, infrastruc- What matters when investors select ture being one of the target investment seg- a mandate manager? ments. Looking at the mandate proposals we Fees and performance are the most typical have already made for 2018, infrastructure reoccurring themes, of course. But at the – even if in absolute terms still behind private same time, the differences between manag- equity – has grown the fastest. Going for- ers can be very small on these two aspects. ward, we would expect to see more mandate A private market mandate is often longer opportunities on the infrastructure side. in term and larger in size than a single fund of funds commitment and the investor’s What do you expect to see in 2019? relationship with the manager tends to be We expect the growth to continue. Lower fees are closer. When choosing a manager, it often Current investors aim at maintaining or comes down to soft factors; it is like choos- increasing their exposure to the private often thought ing a partner: how comfortable do you as market. We continue to see many new to be the main the investor feel with the manager, how investors entering the market and new reason for choosing a well can you communicate with them, how investor segments getting interested. And much do you trust them, how well can they with this overall growth in interest for the mandate over a fund of adapt to your needs? private market, the demand for customised funds commitment A mandate solution provider today mandates will continue. n

24 private equity international december 2018/january 2019 PERSPECTIVES 2019 | SURVEY RESULTS: GP RELATIONSHIPS

PORTFOLIO CONSTRUCTION LPs play the field with relationships

Investors are looking to Received wisdom is that limited partners fund manager relationships over the next expand their GP portfolios are cutting down on their general partner 12 months, according to PEI LP Perspectives relationships. Survey 2019. An additional 30 percent will as access to funds This is certainly true of some. Much has opt to maintain their current number of becomes increasingly been made about California Public Employ- relationships, while just 11 percent will competitive, writes ees’ Retirement System’s efforts to do so; the actively reduce them. Alex Lynn $362 billion public pension had in recent “It’s a cycle; there are periods when years attempted to cut its portfolio back to LPs retrench the number of GP relation- 30 “core” managers to reduce complexity ships that they have and then gradually and the cost of managing the portfolio. increase them again if some of the existing But more than half (53 percent) of managers don't perform and need to be limited partners intend to increase their replaced,” Brad Young, head of global ››

Thinking of your current fund manager relationships, do you plan to make fresh commitments to these managers over the next 12 months?

11.2 9.2 25.0 24.4 32.2

27.3 30.0 31.1

Percentage of respondents Percentage 79.6 47.7 45.6 36.7

Private equity Private debt Private real estate Infrastructure

Yes No Unsure

Source: Private Equity International

Thinking of your current fund manager relationships, would you like to increase, maintain, or decrease the number of relationships?

Private equity 52.6 29.9 11.3 6.2

Private debt 42.9 32.1 22.6

Private real estate 37.1 37.1 5.6 20.2

Infrastructure 28.4 37.5 5.7 28.4

0 20 40 60 80 100 Percentage breakdown

Increase Maintain Decrease Unsure

Source: Private Equity International december 2018/january 2019 perspectives 2019 25 PERSPECTIVES 2019 | SURVEY RESULTS: GP RELATIONSHIPS

›› advisory services at Pavilion Corpora- tion, tells Private Equity International. Do you invest in first-time funds? “A few years ago I’d say all of them were in some form of consolidation of their GP 62.2 56.2 57.6 relationships, and if a group retrenched 51.0 they might now need to expand or increase 35.3 their PE allocation.” 30.6 30.3 31.1 Trimming the fat has its advantages. 9.2 9.2 10.1 Resources are a precious commodity for 5.9

Percentage of respondents Percentage 3.4 2.2 4.4 most LPs, making the ability to commit to 1.2 multiple strategies and asset classes through Private equity Private real estate Infrastructure Private debt fewer relationships invaluable for certain Yes, opportunistically No, we do not invest institutions, Sweta Chattopadhyay, direc- Yes, defined allocation No, but we plan to invest in the future tor, private markets at LP advisory firm Source: Private Equity International Bfinance, says. “It’s actually very hard to prune the How will your average commitment size change over the next relationships back,” Jim Strang, head of 12 months? EMEA at Hamilton Lane, says. “There’s more transparency in private equity today, 69.1 which makes it easier to identify winners. 65.0 63.0 It’s quite difficult to access the most attrac- 52.2 43.5 tive funds because of the dynamics of 35.8 supply and demand, so trying to increase 27.5 22.2 your aggregate exposure while focusing 8.6 7.5

Percentage of respondents Percentage 4.3 on fewer managers is a challenging game 1.2 to square.” Private equity Private real estate Infrastructure Private debt CalPERS is a case in point. The pen- Increase Stay the same Decrease sion plan’s investment advisor Meketa said last year that the Core 30 plan had failed Source: Private Equity International to deliver its intended improvements due in part to a difficulty in deploying larger Thinking of your fundraises in the last 12 months that you expressed amounts of capital with fewer managers. interest in, which of the following describes your experience? Capital is flooding into private equity. Firms raised $266 billion in the first three quarters of 2018, having collected a mam- We have consistently received our full requested allocation in our chosen funds 59.8 moth $464 billion last year, according to PEI We have had our allocation scaled back data. Distributions have also significantly in most of our chosen funds due to 28.0 outpaced private equity capital calls since excess demand We have had our allocation scaled back 3.7 2013, according to eFront data, making it in some of our chosen funds a struggle to put enough capital to work. We have been unable to secure 3.7 Competition for commitments is an allocations in most of our chosen funds unfortunate side effect of this insatiable Have not made any new commitments in 2.4 appetite for the asset class. More than the last 12 months one-quarter (28 percent) of LPs have had Other 2.4 their allocation scaled back in most of their chosen funds due to excess demand and a Percentage of respondents small minority (4 percent) have been unable Source: Private Equity International

26 private equity international december 2018/january 2019 to secure an allocation in the majority of How confident are you that your GPs’ deals have been structured sensibly their preferred vehicles. enough to withstand a downturn? LPs must also contend with managers 100 4.2 6.2 8.5 15.5 that are looking to cultivate their investor

80 base, Strang notes. “What’s happened on 39.5 54.9 the GP side is they've become a lot more 60 62.0 54.9 thoughtful about the kind of investors they 40 want. If their strategy map for the investor 48.1 31.0 28.2 base has got some combination of investor- 20 28.2

Percentage of respondents Percentage type and geography, it means there’s going 4.9 4.2 4.2 0 n Private equity Private real estate Infrastructure Private debt to be some crowding out.”

Very confident Somewhat not confident Somewhat confident Very not confident

Source: Private Equity International Neutral

What is your primary source of fund opportunities, for the following alternative asset classes?

Private real estate 39.6 32.1 18.9 7.5

Infrastructure 41.3 32.6 19.6 6.5

Private debt 40.8 28.6 16.3 12.2

Private equity 44.2 42.9 7.8 5.2

Percentage breakdown

Direct with fund managers Investment Consultants Third-party fund databases Existing GP relationships Placement agency

Source: Private Equity International

How significant a part do the following play in due diligence?

GP performance track record 97.6

GP team size and investment capacity 91.6 8.4

Investment thesis and style drift 89.0 9.8

Firm “culture” at the GP level 61.0 39.0

Fund structural review 60.2 39.8

Succession planning and retention 57.8 41.0 plans at the GP level Fee validation 52.4 45.1

GP balance sheet/financial strength 19.3 66.3 14.5

Gender pay gap at GP level 38.6 56.6

0 20 40 60 80 100 Percentage of respondents

Forms a major part of the process Forms a minor part of the process Not covered in due diligence

Source: Private Equity International december 2018/january 2019 perspectives 2019 27 PERSPECTIVES 2019 | LP VIEW

SOVEREIGN WEALTH FUND ‘This asset class is becoming less attractive’

High prices for assets and a lack of differentiation among GP business models is making private equity less appealing, Future Fund’s head of private equity Steve Byrom tells Adam Le

High prices for assets and a lack of dif- 14.4 percent from 18.9 percent, while debt ferentiation among general partners’ busi- securities also fell to 8.8 percent from 9.9 ness models are making private equity less percent of its total portfolio. attractive, according to the head of the asset “Inflationary pressures are gradually class at Australia’s A$148.8 billion ($105.6 building in the US and markets con- billion; €92.6 billion) sovereign wealth fund. tinue to respond to rising interest rates,” “I’m concerned at the prices being paid Peter Costello, chairman of the Future for beta today, the cost of beta exposure and Fund Board of Guardians, noted in the the ability to continue generating upside at update. “While the short-term economic the prices being paid,” Future Fund’s Steve outlook remains reasonably positive, we Byrom tells Private Equity International in remain cautious about the longer term an interview at the investor’s Melbourne outlook, the impact of geopolitical and headquarters. trade tensions and the potential for shocks The high cost of assets implies private to markets.” equity is a “far more efficient market than it’s supposed to be”, says Byrom. CHINA AND SECONDARIES Private equity sponsors paid on aver- Future Fund is particularly excited about age 14x EBITDA for US assets and 11x in I’m concerned at opportunities in the Chinese market, where Europe last year, according to S&P Global the prices being local GPs are becoming more sophisticated Market Intelligence, and 14.1x in Asia- and are doing “more than just multiple Pacific, according to Bain & Co. paid for beta arbitrage”, according to Byrom. “At a big picture level, this asset class today, the cost of beta “We’re starting to see opportunities to is becoming less attractive,” says Byrom. exposure and the ability put capital to work where we feel very “Business models aren’t sufficiently differ- comfortable with the GPs we’re work- entiated because of the number of GPs in to continue generating ing with,” he says. The fund counts Hong the ecosystem and the amount of capital upside at the prices Kong-based Citic Capital and CDH Invest- competing for a reasonably small number of being paid ments, as well as Beijing-based Hillhouse bidders. Those kinds of competitive dynam- Capital Group among its China-focused ics worry me.” Steve Byrom private equity managers, according to its Future Fund’s private equity portfolio website. grew by 3 percentage points to 14.8 per- The fund has also been using secondaries cent of its total portfolio compared with a to manage its private equity exposure. In year earlier, according to its latest quarterly 2016 Future Fund sold a portfolio worth update as of 30 September. The growth around $1 billion to Canada Pension Plan came amid a drop in its cash exposure to Investment Board, as sister publication

28 private equity international december 2018/january 2019 FUTURE FUND AT A GLANCE THUNDER DOWN UNDER

Future Fund’s PE portfolio has grown by 3 percentage points over the 31 past year Total number of GP A$148.8bn total portfolio relationships

6.5 25.3 14.8 7.0 8.2 8.8 15.0 14.4

3 % Number of Australian Australian equities Infrastructure & timberland PE managers it has Global equities Debt securities relationships with Private equity Alternative assets* Property Cash

* Definition can be found here: www.futurefund.gov.au/investment/how-we-invest/investment-managers

Source: Future Fund as of 30 September 2018

>30% Secondaries Investor reported, and the sov- When it comes to how the SWF incor- Proportion of Future Fund’s PE portfolio ereign investor would consider using the porates environmental, social and govern- invested directly in assets secondaries market again to rebalance its ance issues among GPs into its day-to-day portfolio, Byrom says. Using secondaries is portfolio management, Future Fund is par- far better than scaling commitments up or ticularly looking at social diversity, accord- down, he adds. ing to Byrom. “Some people seem to think that scaling “Our hot topic would be diversity of commitments is a lever to pull to try to get thought, ie, a GP made up of classmates A$148.8bn the portfolio moving. It’s just far too slow from, say, Princeton. It’s not just gender, Total portfolio as of 30 September moving to have an impact within three or it’s also experiences and different ways of four years.” looking at things that they bring to the table While some firms such as BlackRock – upbringing, education, background, dif- and KKR have launched products like long- ferent societal norms.” term funds to hold assets for longer, Future Future Fund was established in 2006 Fund is not the type of investor to commit to strengthen the Australian government’s 9.2% to such strategies, Byrom says. long-term financial position. The sovereign Total fund return a year over a 10-year period “There are pools of capital where that’s wealth fund invests five funds: Future quite appropriate and it works, and there Fund, DisabilityCare Australia Fund, are other pools of capital where it doesn’t Medical Research Future Fund, Building make sense to do,” he adds. “We’d probably Australia Fund and Education Investment Source: Future Fund; data as of 30 September 2018 put ourselves in the latter camp.” Fund. n december 2018/january 2019 perspectives 2019 29

KEYNOTE INTERVIEW: EFRONT

PERFORMANCE Reinventing LP-GP data exchanges and analytics

Investors want more The data revolution may have made enor- But that thirst for information is putting information about where mous amounts of information available to a strain on GPs. They can’t provide data GPs and LPs, but it remains a burden to in different formats and different ways for their money is going and manage. Private Equity International sat down each and every LP. So they find themselves that is putting a strain with Tarek Chouman, the CEO of eFront, either serving their biggest LPs, say the top on fund managers. GPs to find out how technology can lighten the 10 or 20 percent of their investors, which can gain a competitive load and what it means for the alternative can immediately frustrate the other 80 or asset industry when all this data isn’t just 90 percent, who are not getting the data advantage from accessible, but also understood. the way they want. managing these requests There’s no world where today’s investors And this is precisely where we come into effectively, says eFront start asking for less data, or stop making the picture. Because we are able to provide CEO Tarek Chouman additional requests beyond that last quar- the tools that are going to allow them to terly report. And by the very nature of the automate, optimise and streamline this data business, as any GP matures, they will grow exchange, even as the amount of data for in size, which means more portfolio compa- any GP to manage grows steadily. And I’d nies and more data to manage and report. argue that any GP’s ability to manage their That’s where today’s technology plat- data can become a competitive advantage. forms step in and automate as much of this This isn’t just about investor reporting per data exchange as possible. Software solu- se, it’s about securing the commitments to tions provider eFront has long been on the the new fund. cutting edge, understanding that manag- ing alternative assets is very much about We have heard that LPs value fast, managing data. Chouman knows the gap accurate reporting. Is that the advan- between LP expectations and GP capabili- tage? ties, but believes that technology can make It’s more fundamental than that. Data can the most of the data that’s already available serve as a reality check, and can help differ- today to make better decisions. entiate one manager from another. This isn’t about better service, though that’s impor- What’s the current environment for tant. It’s about LPs using more robust data the exchange of data between GPs to select managers through sophisticated and LPs? analysis powered by the latest technologies. LPs of all kinds, from sovereign wealth How can investors chose a manager funds to high-net-worth investors to mas- when the managers are all telling the same sive institutional investors, are looking to story? When they refer to themselves as top extract more information about where quartile, what is that based on? Data can their money is going, especially as they seek substantiate these claims, and our latest additional alpha. They want to better under- offering Insight can help LPs see where a stand performance, risk and benchmarking. GP sits and where its true source of value

Chouman: thirst for information is putting a It’s happening worldwide, and we think it’s creation lies. Granular data that used to strain on GPs a revolution that’s underway right now. sit buried in a manager’s Excel spreadsheet

30 private equity international december 2018/january 2019 KEYNOTEKEYNOTE INTERVIEW: INTERVIEW: EFRONT J-STAR

is now accessible to LPs, more than ever LPs are keen Insight solution. GPs are as interested as LPs before. Investors often have to pay steep fees to get to the in accessing this level of analytical capabili- to advisors to get this kind of intel, and now ties to perform some self-assessment. We it’s readily available. And given that most LPs bottom of are proposing the same analytical platform are constrained in terms of resources, these the true sources of to our GPs who contribute their data – and platforms can make a massive difference. value creation of their they are genuinely learning so much about themselves. Has there been any pushback from managers GPs on making that information, Where do you see the industry going once hidden in Excel, more available to from here? LPs? In the last 15 years, the pace of change has We sit between GPs and LPs, so we’re of our highest priorities. We leveraged our been staggering. Just three years ago, we clearly sensitive to the needs and priori- 20 years of experience when designing started our eFront Data Intelligence offer- ties of fund managers. But we believe that our system, with penetration tests, strict ing dedicated to facilitating the exchange of today’s private market players have nothing governance over access rights, and secure data between LPs and GPs before anyone to hide, and nothing to be shy about. On hosting capabilities with the right level of was talking about that. However, as much the contrary, disclosing that track record confidentiality every step of the way. It’s as we invest in our future, LPs are going to is going to draw more attention, and win vital to our business to protect a client’s drive the next generation of innovations. more fans, which naturally means more data and their relationships. They’re beginning to see the potential for commitments. Unless a manager is failing, not just more data, but data they can pro- we see no threat from transparency. On How can LPs make sense of all the cess at an accelerated pace to make better the contrary, we believe open books can data they are increasingly having decisions. They can pool their data requests mean full coffers. access to? through a platform like ours and get what Because data isn’t just a tool for LPs Digitalising and enhancing data exchanges they need to improve their manager selec- looking to vet managers. It can help a GP between LPs and GPs is not the endgame. tion, no matter the size of their commit- stand out from their peers, by backing up The main purpose is to enable superior, ment. In that respect, initiatives such as their track record. That smaller manager in more sophisticated analysis that will bring those driven by ILPA to harmonise data China might be able to catch the attention some more factual reasoning into the alter- requirements from LPs are positive cata- of a large pension fund in California by a native investment decision-making process. lysts. data-rich testament to their own perfor- The mere benchmarking of performance Although, this isn’t just about making mance. The level of data out there today is through skewed industry benchmarks will LPs savvier. The enhanced ability to meas- a reality check, but if a manager is an actual soon be insufficient for an LP to measure ure risk and performance and factually contender, it can make them look better, performance. LPs are keen to get to the assess investment opportunities is going and rightfully so. bottom of the true sources of value creation to make more investors willing to invest of their managers, down to asset and indi- in private markets, which are still a very How does a firm like eFront balance vidual partner level. To achieve that level of small part of the financial industry in the appetite for so much data, with sophistication, they need to combine mul- terms of AUM. Better transparency has the need to ensure that data is secure? tiple and granular data sets into a powerful the potential to grow private markets in We operate on a trust-based relationship analytical tool. This is precisely what we the future, and that’s what excites us about with our clients, so data security is one offer with our recently launched eFront our business. n december 2018/january 2019 perspectives 2019 31 PERSPECTIVES 2019 | SURVEY RESULTS: SECONDARIES

SECONDARIES A firm anchor in LPs’ minds Expect another year of It’s full steam ahead for the secondaries of the market: according to the survey, just healthy trading in the market. As of late November the top 10 under half of LPs plan to be active in the largest secondaries funds were seeking a private equity secondaries market either as market for second-hand combined $51 billion, according to PEI data. a buyer, a seller or both. fund stakes, writes This includes the latest vehicles from Ardian The picture is less rosy in other asset Adam Le and Lexington Partners, both seeking $12 classes, with around 20 percent of LPs in billion – the largest amount ever sought real estate and infrastructure and around for the strategy. 7 percent in private debt saying they plan It will be of comfort to these large firms to buy or sell interests. that LP appetite for the strategy remains “It has become much more a part of strong. According to the PEI LP Perspectives normal business for LPs to manage their Survey 2019, at nearly half of LPs plan to portfolios in private equity but other strat- commit to secondaries funds over the next egies are lagging behind,” Engelien says. 12 months, a sign that high pricing for sec- While the survey results for real estate are ond-hand fund stakes and falling returns for surprising, most infrastructure investors the strategy have not deterred LPs just yet. are pension funds and life insurers that are “It looks like the strategy is firmly typically underallocated to the asset class, anchored in LPs’ investment agendas and and therefore selling has “not really been a is here to stay,” says Bernhard Engelien, a topic” for them, Engelien says. Private debt, managing director at advisor Greenhill. meanwhile, is too young an asset class to see LP portfolios or “plain vanilla” transac- meaningful deal volume, although Greenhill tions comprised the bulk of deal volume in is seeking second-hand stakes in some senior the first half of this year. Looking into 2019 lending funds coming to market, he adds. secondaries buyers can rest easy in this part But when it comes to GP-led transactions

Do you plan to buy or sell fund stakes on the secondaries market in the next 12 months?

19.8 22.2 24.7 30.8

32.6

4.7

Percentage of respondents Percentage 22.1 58.0 55.6 4.9 3.7 59.0 8.6 12.3 20.9 5.1 6.2 3.7 Private equity Private real estate Infrastructure Private debt

Yes, both buying and selling Neither buying nor selling Yes, buying only Unsure Yes, selling only

Source: Private Equity International

32 private equity international december 2018/january 2019 GPs are increasingly instigating restructuring processes on old funds in order to move assets into a new vehicle. In these circumstances, do you believe:

You have sufficient information to You have sufficient time to decide The costs of the process was fairly decide whether to roll over or cash whether to roll over or cash out? divided between the GP and the out? fund?

35.3% 22.0% 32.5% 42.4% 44.6% 42.7%

22.4% 22.9% 35.4%

Yes Yes Yes No No No Have not been party to a restructuring Have not been party to a restructuring Have not been party to a restructuring

Source: Private Equity International Source: Private Equity International Source: Private Equity International

– secondaries processes such as fund restruc- Do you plan on committing capital turings or stapled tender offers which are to secondaries funds in private initiated by a manager – many LPs remain equity over the next 12 months? sceptical, with more than one-third feeling the costs were unfairly divided between the 11.5% GP and the fund, according to the survey. With the Securities and Exchange Com- mission’s fining of buyout firm Veronis Suhler Stevenson in September in relation to a GP-led secondaries deal, and the Insti- tutional Limited Partners Association set to issue guidance next year on such transac-

47.1% tions, there will be increased pressure on 41.4% GPs over the next 12-18 months to provide greater transparency.

Yes “There will certainly be greater empha- No sis on having LPs’ interests being better Unsure represented in these types of transactions,” Source: Private Equity International Engelien says. n december 2018/january 2019 perspectives 2019 33

KEYNOTE INTERVIEW: EVERCORE

SECONDARIES A bigger, more nuanced market

Armed with the most recent data, Nigel Dawn, senior the market, followed by pension funds and managing director at Evercore, reflects on the growth asset managers. If you compare 2014 and 2017, GP of the secondary market, what has surprised him the liquidity solutions has risen to become most in its evolution and where he sees it heading in almost 25 percent of the market. Also, asset the next decade managers and primary fund of funds sell- ing have generated a large tertiary market Can you illustrate the growth of the for secondary funds to participate in. This secondary market over the last 15 development is natural given the “bubble years? vintages” were from 2004 to 2008. During The 10 top secondary funds raised in 2004 these years, funds of funds raised their larg- aggregated to $13 billion. Fast forward to est funds. Therefore, it’s not surprising that 2018 and the total rises to around $77 vehicles that are 10 years or older are now billion, again for the top 10 funds. That’s being sold. greater than five times growth and also a Public and private pensions continue to significant amount of capital. This growth be very important, but the key change is is being driven by very strong investment GP liquidity solutions and asset managers results and, worth noting from an IRR per- as key sellers. In the first half of 2018, GP spective, secondary returns are surprisingly solutions and direct transactions accounted close to what has been achieved in the pri- for 37 percent of the market, up from 19 Dawn: dramatic change in the profile of the mary buyout market. market percent in 2014. This year, we would expect In 2004, there was a relatively small GP liquidity solutions to take 35 to 40 group of secondary investors. In 2018, as an secondary funds raised in 2004 with 2018, percent of the total. That’s a huge increase advisor, we’ve sold assets to over 100 inves- it is essentially the same group: nine of the over four years – one I just wouldn’t have tors. That’s a dramatic change in the number 10 are the same firms. One has left, Paul imagined. of secondary investors compared with 2004. Capital, and one investor has joined, Alpin- The other big change from 2004 is spe- Finally in 2004, there wasn’t a single sec- vest. The remainder are the same. The order cialisation. In 2004, the transactions were ondary fund in the top 10 private equity of the top 10 has changed as some groups all fairly vanilla: sales of portfolios of LP funds raised. In 2018, five of the top 10 have become more prominent. interests, that were highly mature. If you funds are secondary funds. This provides A lot of capital has been raised by sec- look at investors now, some specialise in clear evidence of the significant increase ondary investors. However, a significant early secondary positions or structured in the importance and scale of the second- amount of capital has also been raised in transactions, some use leverage, others ary market. the overall private equity market. Therefore, will focus on staple transactions. There’s a on a relative basis, secondary sales volume big variety, even within LP positions. Some What do you think has remained as a percentage of all private equity assets firms also specialise in GP-driven transac- stable in the secondary market? has remained stable. The secondary market tions. There is also the emergence of the The amount of dry powder in the market volume is roughly between 1 and 1.5 per- preferred equity market which has devel- is still very concentrated in a few hands. cent of the outstanding NAV. oped in the last few years. Fourteen buyers represent 80 percent of Specialisation within the secondary the dry powder. Even though there are many What are some of the big changes? market is not surprising. As industries more secondary investors, the capital that’s The sellers have changed. This is a develop, the largest groups get larger and available to be deployed in the market is still market that used to be driven by financial the smaller groups tend to be more spe- highly concentrated. institutions. Banks and other financial insti- cialised. It’s the groups in the middle that Also, if one compares the top 10 tutions accounted for 35 to 45 percent of get squeezed.

34 private equity international december 2018/january 2019 KEYNOTEKEYNOTE INTERVIEW: INTERVIEW: EVERCORE J-STAR

What does this mean for return 2014 TRANSACTION VOLUME 2017 TRANSACTION VOLUME expectations? – SPLIT BY SELLER TYPE – SPLIT BY SELLER TYPE I think there’s an expectation that the more complex the secondary transaction and the 6 7 4 more concentrated the assets being pur- 41 23 9 9 28 24 19 10 3 7 chased, the higher the expected returns 5 5 should be. There’s probably more bifurcation in terms of returns for the sub-strategies. Most % % secondary groups invest across GP transac- Financial institutions Asset managers tions and LP transactions. The relative mix of Public & private pension plans GP liquidity solution GP liquidity solution Public & private pension plans those strategies will determine the returns. SWFs Financial institutions Endowment/foundation Endowment/foundation Is risk-taking going up in the secondary Funds of funds SWFs market? Family office Family office Other The risks are very calibrated. In the more

Source: Evercore Source: Evercore traditional businesses, LP portfolios are diver- sified across many companies. Perhaps the STABLE MARKET biggest single change is the common use of leverage as part of the capital structure. The Secondary market volume ($bn) risk is higher when investing in more concen- 8 7 10 15 20 10 22 26 27 26 47 42 37 54 trated portfolios or direct companies, such as in GP-led transactions, so one would expect returns to be higher for these transactions.

Where do you see the secondary market in 10 years? The market will continue to grow. Market

Private equity AUM ($bn) AUM equity Private volume in 2018 should be between $65 Secondary turnover rate (%) Secondary turnover rate billion and $70 billion. That compares with 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 $8 billion in 2004. Within the next few Total AUM (globally)* Secondary turnover rate years, I’d expect annual volumes to rise to Source: Evercore * Global PE, excluding real estate and private debt $100 billion. Differentiation among second- ary funds will also continue. There will be 2018 – TOP 10 FUNDS CAPITAL REMAINS HIGHLY much more nuance among investors. CONCENTRATED WITH A Fund size ($m) I would expect the GP-driven part of Apollo $24,714 FEW FIRMS the market to reach 50 percent of volume The Carlyle Group $18,500 Dry powder as of 30 June 2018 – in the next few years. This is a huge change. SilverLake $15,000 concentration This is partially driven by GPs consider- EQT $13,226 $64bn ing the secondary market as an exit option Ardian $12,000* 100% for individual companies. The market for Lexington Partners $12,000* 90% Top 20 Top 14 buyers KKR $9,300 buyers = (>$800m) single-asset secondaries is here to stay. 80% of dry 80% powder I spoke to a GP the other day about Coller Capital $9,000* Top 14 Strategic Partners Fund Solutions $8,000* buyers (>$1.5bn) his plan for a company and he said: “We’re Goldman Sachs $7,200 50% thinking about a trade sale, an IPO or a Top 6 Secondary buyer buyers secondary.” One would have not heard that (>$3bn) Includes 2018 vintage buyout funds (closed) and secondaries 30 June 2018 dry powder 18 months ago. It’s a fairly dramatic change funds that are both closed and currently raising; source: Evercore databases and Prequin Notes: includes dry powder for dedicated infrastructure and real in terms of the importance and profile of 8 Funds currently raising estate secondary funds Source: Evercore Source: Evercore the secondary market. n december 2018/january 2019 perspectives 2019 35 PERSPECTIVES 2019 | LP VIEW

WILLETT ADVISORS Rattner: Credit quality deterioration ‘well underway’

Steve Rattner, the Rattner on … how the global financial credit for what they did. This could have chairman and chief crisis came about been 1929, this could have been the Great It was a combination of factors that include, Depression, it could have been a financial executive of Willett in no particular order: poor regulatory Armageddon, and we’re really very fortu- Advisors which manages oversight from the federal government in nate that those three guys and a lot of other the personal and terms of really understanding what was people really did save us. There’s no doubt philanthropic investment going on in the financial system and in about that. curbing things that we later knew to be The second message they’ve been assets of Michael excesses; and poor risk management on the conveying, which I agree with, is we are Bloomberg, shared part of a lot of banks and other financial actually in some ways better prepared for his thoughts on the US institutions, who were buying things that the next crisis and in some ways worse. economy at the PDI New they either didn’t understand or overpaid Essentially the Fed[eral Reserve] and the York Forum in September for or got out in front of them. federal government did what it could to I remember in the summer of 2007 I put us back on a growth trajectory, so was helping Mayor Bloomberg buy back when you look at how fast the economy part of the interests in his company that turned, how fast the stock market turned, Merrill Lynch owned at the time. I sat it really is quite remarkable. We’ve now down and tried to read Merrill Lynch’s had a long period of sustained growth, financials and I couldn’t understand any of low inflation, low interest rates. We are it – it was so complicated, there was so now in the longest post-war expansion much off-balance sheet stuff, there were in history, we’ve had 124 months, and so many what we used to call the SIVs and things are going pretty well. The biggest the conduits and all this stuff. I remember concern I have is that growth has been thinking, ‘This is a very unusual way to run somewhat slower than normal and pro- an institution’ and of course it didn’t really ductivity growth – very, very importantly work out very well. – has also been slower than normal, and It all came together in this perfect storm that does tend to cause slow GDP growth. where you had over-leveraged banks – Bear Stearns first and then Lehman Brothers – …when the next downturn might hit and then this cascading effect into Fannie There was a study done not too long ago and Freddie [Mac], into Citi and [Bank by The Economist which found that over a of America], AIG and so on. And then of 15-year period, of 220 instances in which a This could have course the financial effects spilled over member’s economy contracted in the year- into the real economy and that caused a ahead, not once did the IMF forecast the been 1929, this recession. downturn. could have been So before any of us say ‘We’re going to the Great Depression, …where we are today have a recession next year’, I think we have Hank Paulson, Tim Geithner and Ben Ber- to be humble about it. it could have been a nanke have been doing a number of ses- Economists like to say that recoveries financial Armageddon sions [at forums]. [They] deserve a lot of don’t die of old age, but they kind of do. You

36 private equity international december 2018/january 2019 PERSPECTIVES 2019 | LP VIEW

I really think that power – and that was a Rattner: inflationary pressures need to be carefully watched political decision – would have been better vested in the Fed.

…on what keeps him up at night I do worry about the trade war; tariffs are a tax, taxes slow the economy, trade is good for an economy, I think that’s been well proven, and if we get into a trade war and the amount of trade drops off, that’s also bad for economic growth. The second thing is this build-up of inflationary pressures that one can vaguely see. I think it is a potential worry and some- thing we should really keep a close eye on. I think the recent moves in 10- and 20-year treasuries may be signalling something, we’ll see, but we should be watching those unemployment numbers and the wage numbers and the consumer price index numbers and the personal consumption expenditures numbers very, very carefully. The third thing I worry about is that, get imbalances in the economy, something to provide emergency lending assistance to on paper, what’s happening in the Howard gets out of whack, you start to get inflation- failing institutions. And that is a very scary Marks world of ‘too much money chasing ary pressures, or you get these poor credit situation. Because while you can hate the too few deals’, is visible. You can see that quality instruments floating around. But it’s bailouts, or believe, as I might, that there are spreads between high yields and invest- really, really hard to predict. As I sit here, I some things that could have been done dif- ment grade loans are not all the way back will fall into the trap of saying I think we’re ferently, that would have created less popular to where they were right before the global still in a recovery mode for as far as I can see, resistance to them, it was the ability of the financial crisis, but they’re pretty darn close. but for the next year or two it’s very hard Fed and the Treasury to move in that really And there are other measures, like the share to see what would derail the recovery. The saved us from Armageddon. of deals being done through covenant-lite stock market might be a slightly different There’s a second thing in Dodd-Frank structures, that also tell you things are scary. issue. But we are growing rather quickly, that I don’t like. They have set up a better And you can also look at the debt ratios that we still have quite low inflation, we don’t mechanism – and this is a plus – for wind- are going into private equity deals – the see those kinds of imbalances, at least not ing down failing large banks. The Federal Fed had a policy that they didn’t want more from where we’re sitting, again with a big Deposit Insurance Corporation has always than six times debt to leverage in private note of humility. been able to deal with failing little banks, equity deals, that has sort of been nudged but wasn’t in a position to deal with fail- up a little bit. …on regulatory weapons to fight a ing large banks; they’re just so complicated. There are indicators in every direction downturn They gave to the FDIC the authority to that while most of the really crazy financing In reaction to the so-called bailouts of the make sure the subordinated lenders and the structures that existed at the time of the banks and financial rescues, which were equity holders in those banks take haircuts, great financial crisis have been taken off unbelievably unpopular among the people which didn’t happen last time because it just the table, the more conventional, simple and still are to this very day, as part of Dodd- couldn’t be done structurally. While very act of credit quality deteriorating in a bull Frank, Congress took away from the Fed and good at saving little banks, the FDIC doesn’t market is obviously well underway and is the Treasury a fair amount of their power know anything about saving big banks. And a scary situation. n december 2018/january 2019 perspectives 2019 37 PERSPECTIVES 2019 | SURVEY RESULTS: CO-INVESTMENT

INVESTMENT STRATEGY The co-investment conundrum Co-investments have become standard in private equity, but arrangements between LPs and GPs don’t all fit the same mould, writes Marine Cole

In an environment where limited partners promptly. Or they may reach out to other are trying to maximise returns and lower Do you plan to invest in potential partners outside their main fund.” their fees, co-investments have become an co-investment opportunities Co-investments also differ in terms ordinary component of the private equity in private equity over the next of the structure GPs adopt once they are landscape and of relationships between LPs 12 months? about to make a specific investment. and general partners. The majority of general partners offer- 11.6% Nearly two-thirds of LPs plan to invest ing co-investments structure these trans- in co-investment opportunities, according actions as a separate entity as opposed to to the PEI LP Perspectives Survey 2019. direct investments in a portfolio company. “In the last five years, co-investments Gallagher believes it’s always better to went from being pretty common to ubiq- be in the same vehicle as the sponsor of uitous,” says Brian Gallagher, a partner and the deal, but adds that “as long as we have co-founder at Twin Bridge Capital Partners, the right protection and rights, it’s form which often co-invests alongside its GPs. “It’s over substance”. gone from a topic at most fundraising meet- John Guinee, managing partner and co- ings, to a topic at every fundraising meeting.” 23.3% 65.1% founder of Constitution Capital Partners,

But no two co-investment situations Yes also a frequent co-investor, thinks the type are the same and specific arrangements No of structure varies depending on the size between managers and co-investors in the Unsure of the GP and that the creation of a limited same deal often vary greatly. Source: Private Equity International partnership with co-investors is typically Initially, GPs offer co-investment oppor- tunities to their LPs in different ways. “I’m seeing some sponsors forming spe- Which factors hinder your participation in co-investing opportunities? cific co-invest funds ahead of time, antici- Please select all that apply. pating that they’re going to need additional capital for specific investments that their Risk level 36.0 main fund will make,” says Babak Nikravesh, a partner with Hogan Lovells and the co-head Speed required to conclude transaction 36.0 of the firm’s sovereign investor practice. Lack of supply of available 33.7 “But most people actually do it on an à co-investment opportunitites la carte basis. They realise they need more Not staffed up for it 33.7 money for a particular investment, maybe because they’re up against their percent- Ticket size required 24.4 age cap on how much they can invest per Lack of opportunity to be 22.1 company and they have to go out and raise invited to participate money from other institutional investors. Typically they will reach out to the people Other 9.3 in their main fund, often preferred LPs who they hope will re-up in another fund Percentage of respondents and which they believe can provide capital Source: Private Equity International

38 private equity international december 2018/january 2019 indicative of a bigger group of co-investors and often of a larger GP. “The sponsor needs to create a mecha- nism so it doesn’t have to deal with each co-investor at a time,” he says. “The bigger the sponsor is, the less they want to deal with co-investors anymore.” Co-investment arrangements also differ based on the types of fees and expenses being charged. One of the main drivers behind institutional investors wanting more co-investments is the ability to avoid paying management fees and carried interest on such deals. The fee structure depends on how close the links are between the LP and the GP. “If it’s a true co-investment that you’re offering to LPs in an existing fund, a no fee, With so much money flowing into pri- It’s gone from no carry arrangement is pretty typical, but vate equity funds and such a great interest a topic at most there’s a lot of variation,” says Nikravesh. among LPs for co-investments, the nego- Gallagher notes that overall, whether a tiating power has tended to swing into the fundraising co-investor pays management fee and car- hands of fund managers recently as opposed meetings, to a topic ried interest depends on if it is also an LP to co-investors. at every fundraising in the main fund. As co-investment transac- “For savvier GPs, they’re recognising tions become larger, if interest among LPs that co-invests are a hot commodity, and meeting from the main fund is not sufficient, GPs they may have the ability to command Brian Gallagher tend to reach out to investors who have not some alternative fee arrangement involv- invested in the main vehicle. ing some form of management fee and/or “If you are not an LP in the fund, I think carry depending upon the deal and LPs in it’s totally reasonable to be charged a man- question,” says Nikravesh. agement fee and carry,” he says, adding that This is especially true for strong per- Twin Bridge only co-invests with existing forming money managers. But for first-time managers. funds or managers starting a co-investment Guinee agrees co-investments for exist- programme, co-investors can still have the ing LPs should be no fee/no carry. “Organi- upper hand. sational and set up fee is all we ever see and It remains to be seen whether a down- that’s the only one we pay,” says Guinee. turn in the economy will modify co- “All the other fees – management fees and investment appetite among LPs and as a carried interest, that’s more indicative of result will impact LPs’ and GPs’ negotiating bigger funds,” he adds. power. n december 2018/january 2019 perspectives 2019 39

KEYNOTE INTERVIEW: DEBEVOISE & PLIMPTON

CO-INVESTMENTS Sharing isn’t always easy

Today almost every GP With so much demand for co-investment on co-investors who all want more of the deal is obliged to provide at the part of investors, and so many promises than they are getting. In those cases, the LPs of opportunities from fundraising sponsors, that do well are the ones who work well least some co-investment there is a growing sophistication in execu- with the sponsor and make the effort to deals to investors. tion. Here, Katherine Ashton, partner at the understand the dynamics and the timetable Debevoise & Plimpton’s law firm Debevoise & Plimpton in London, of the underlying transaction. Other times Katherine Ashton outlines tells Private Equity International what she is there is one LP with a significant piece of the issues at stake seeing in terms of issues and resolutions. a large deal. Ten years ago, sponsors would do deals Why are co-investments now hap- and then afterward look to lay off part of pening with greater frequency? the risk by bringing in co-investors and Firstly, club deals, where PE firms band syndicating out pieces. That still happens, together sharing governance as well as but now it’s much more common for LPs money, are on the wane. There have been a to be brought in earlier by the sponsor, lot of not particularly successful deals, and before the deal has closed. Then there is it is time consuming and difficult to negoti- a lot more time pressure, but there’s also ate the governance around who makes the more opportunity to potentially influence decisions. That means sponsors that want to the structure. invest in large deals are increasingly likely to favour relatively passive co-investors. Do co-investments work better for Second, we have reached a point where specific types of LPs? Are there new the co-investment rights that LPs have been entrants coming into the market? demanding as a price for coming into pri- Not all the LPs doing deals are traditional mary funds are coming to fruition. In recent private equity players. We see sovereign years, those became a standard request, and wealth funds, and new entrants including today almost every GP has some obligation institutional investors from other parts to show co-investment deals to some inves- of the world, who may be interested in tors. For LPs, these deals represent a way the direct dealflow and exposure that co- to diversify and show some great returns. investments offer but are not always set up to make decisions as quickly as sponsors What are sponsors’ motives in bring- need them to. ing in co-investors? And are pre-clos- On the other hand, a sovereign wealth ing or post-closing opportunities more fund may have so much money and so much common? potential influence with the sponsor that The question is whether the sponsor is it can participate in a very meaningful way offering the opportunity just because they and materially impact transactions. It’s all promised they would or because they genu- about relationships – there aren’t a lot of inely want to lay off part of the expense and structural barriers to coming in and doing the risk. Both motivations are common, but co-investments; it is whether you can per- they affect the dynamic and the process. suade the sponsor to give you a piece of the Ashton: club deals are on the wane Sometimes there are a number of action. Sponsors are wary not only of the

40 private equity international december 2018/january 2019 KEYNOTE INTERVIEW:KEYNOTE DEBEVOISE INTERVIEW: & PLIMPTON J-STAR

reputation of the LP, but also of the risk aligned with the interests of the sponsor, so There’s an that something goes wrong in the future the sponsor cannot dilute the LP by putting eagerness to with the investment and the sponsor may more money in, for example. If the sponsor need to work with that investor to put in decides to sell, the co-investor should be have more additional capital or restructure the deal. able to go along. direct exposure to the If you’re an LP, you want to go into a magic value that a really How do LPs react to sponsor contacts deal with the understanding that you will undertaking co-investments with make or lose money to the extent that the good sponsor can bring other (potentially rival) LPs? sponsor does, so you want to make sure I have not come across that as a major issue. the legal structure allows for that and that Yes, there is competition, because LPs are will continue to be the case down the road. quite often scaled back and get less of the but also to get the right price and manage deal than they want. But everyone acknowl- To what extent are major institu- that investment through to a good exit edges sponsors have numerous demands tional investors turning to co-invest- and a good return. The co-investor gets to and LPs need to distinguish themselves by ment opportunities instead of commit- tailor its portfolio, but it may end up very being easy to work with. ments to more traditional fund vehicles? exposed to one manager. Co-investments are significant transac- Could the co-investment model overtake Some co-investors may not have the tions and need to be taken seriously. But traditional funds? background and resources to adequately they are a different kind of negotiation, In our experience of the market today, there appraise an opportunity – the best ones because it’s not winner takes it all in the are a lot of people with a lot of money to don’t just work very well with GPs, but way it is when negotiating M&A. Instead, invest, and it is not a zero-sum game of are also rigorous in their analysis and know these deals are driven by long-term rela- one or the other. For most major investors when to say no. tionships – the parties already do business working with fund sponsors that they trust From the sponsor point of view, the risk together in lots of different ways and want and have done well by, there’s an eagerness is that you bring other people into your to do business together again. to have more direct exposure to the magic situation, and if something goes wrong they value that a really good sponsor can bring. complain. Plus, there is the execution risk What structuring aspects of a co- It is about diversifying and coming up of bringing them in, and, in theory, the investment spark the most debate with a bespoke solution. If you are an LP highly unlikely but terrible scenario where between LPs and GPs? investor with a really great sponsor and a sponsor may have committed to pay X, If you’re going into a deal pre-closing, then you need more exposure to, say, Southern the co-investor agrees to pay Y, and then the an important issue is what happens if the Europe, then co-investment is a great way co-investor defaults and the deal collapses. deal doesn’t close – how do you split up to pick and choose and construct a port- Sponsors today are moving toward expenses, for example, and also what abil- folio more attuned to your assessment of standardising their co-investment docu- ity does the sponsor have to force the co- the market. mentation as much as they can because investor’s hand if the terms change a little. nobody wants to be dealing with the same Once you get through the deal, the What are the risks of co-investments? issues over and over again when bringing most important thing is the governance As an LP, you are piggy-backing on in more parties to a deal. The bigger spon- and structuring arrangements by which the a sponsor. So, although you may have some sors are increasingly working to make it co-investor is brought in. When represent- opportunity to do due diligence and struc- more cookie-cutter deal-to-deal, and I think ing an LP, you have to look carefully to make turing, in essence you are trusting the spon- that standardisation will continue as the co- sure the interests of the LP continue to be sor not only to identify a good opportunity, investment market continues to mature. n december 2018/january 2019 perspectives 2019 41 PERSPECTIVES 2019 | LP VIEW

KEY QUESTIONS On the minds of top LPs

From dealing with stressed portfolios to handling ESG issues in portfolio companies, investors tell us the issues that keep them awake at night

What are the most promising regions What issues keep you awake and strategies in 2019 and why? at night?

Marc Lau: Risk in all its forms could be ML: The increasing encroachment of poli- attractive in 2019 if safety is prized. tics into business. Patient capital remains uniquely posi- tioned to take advantage of mispricing MS: Private equity stops outperforming and has the long-term orientation to wait public markets by an attractive margin; for mean-reversion. industry perception; and ESG issues in portfolio companies. Marcus Simpson: North America, Asia- Pacific, and Europe – with a preference DW: Many GPs are scaling (too) quickly for venture, growth and smaller buy-outs – how do we separate the winners from – remain attractive: We like the gains made losers? by investing well into businesses, growing them with talent and capital and position- ing them for the next shareholders.

Daniel Winther: For me, a one-year per- spective does not mean much. Over time, Many GPs are specialisation will continue to deliver the most attractive returns regardless of scaling (too) region and asset class. quickly – how do we separate the winners from losers? Daniel Winther

42 private equity international december 2018/january 2019 PERSPECTIVES 2019 | LP VIEW

What’s your one piece of advice What surprised you most What’s the biggest challenge for GPs? in 2018? in 2019?

ML: The principles for success in PE rarely ML: While not surprising to individual ML: To have the courage of your convic- change – stick to what you know, focus on users who value individual convenience, tions if sentiment diverges significantly carry and have strong alignment of interests data privacy concerns have not seemed to from fundamentals. with investors and investees. alter user behaviour as much as the press or stock market attention it has generated. MS: Balancing investing in attractive busi- MS: Combine your good work on outper- nesses (that we still find at this point in forming public markets with an increased MS: US economy growing by more than the cycle) with keeping powder dry for focus on ESG, especially diversity and trans- 4.0 percent real in a quarter. opportunistic investments if/when there parency. is a future downturn DW: The persistent appetite for mega- DW: Make sure the ratio between number funds makes no sense. DW: Keeping up realisations with invest- of portfolio companies and investment pro- ments. n fessionals is not at max. If the portfolio is put to stress, a few bad deals can take up a disproportionate amount of your time. OUR INVESTOR PANEL

Marc Lau, managing partner, Axiom Asia Private Capital

Marcus Simpson, head of global private capital, QIC

Daniel Winther, head of private equity and infrastructure, Skandia

december 2018/january 2019 perspectives 2019 43

KEYNOTE INTERVIEW: MVISION

FUNDRAISING Why mega-funds are on a roll

MVision’s CEO Mounir Guen talks huge fundraises, new into their investment exposures with their pools of capital and the value opportunities from Brexit eyes open. The industry has enough sea- soned professionals who have been through a shock and there’s a huge amount of dis- Looking big picture, what has been closure to investors and dialogue. the key theme of 2018? The private equity community has This year was really all about mega-funds learned from the recent financial crisis. On and that trend will continue. Investors have one side of the equation, they are buying been highly focused on the US market and great companies and continue to gener- still are. If they are investing in 10 GPs, they ate outstanding returns. And on the other, are easily investing in eight in the US, as the interest rates are still low, and many GPs are returns have been very prominent. And that finding alternative sources of financing that is why US GPs are able to get bigger and are covenant-light or free. Creative financ- bigger. Many are doubling their fund size ing with a lot of covenants is not part of and they are still having allocation stress. the equation today and the portfolio risk There’s rising demand for European GPs profile is quite different. It doesn’t mean because investors are significantly under- there won’t be a problem somewhere or Guen: LPs are nervous about rising prices weight in Europe and can’t ignore a market a portfolio company won’t go wrong. But of half a billion people with the rule of manage their portfolios very carefully. Right these are outliers. law, bankruptcy laws, financial and capital now, with the equity markets so high and markets infrastructure and a lot of noise. when we’re approaching the end of the With the US and European markets There’s a lot of inefficiency and opportunity cycle, the question is: should an investor be so bullish, are LPs still looking at other to capture value partly caused by Brexit, more cautious or continue to invest a regu- geographies? and other government changes. lar amount of capital consistently? I believe The interest in new markets like Latin they should do the latter and the reason is America or Africa and even parts of Asia Can funds continue to grow? that private equity firms, particularly at the is extremely limited. Not because of lack Yes. Managers will grow in terms of larger end, are buying great companies. If of opportunity or experience, but due to business structure, the number of alterna- they are expensive that’s fine. At the end of local currency volatility relative to the US tive vehicles they manage and assets under the day, these companies are well positioned dollar and the net dollar returns. For local management. Individual fund sizes are with strong operational infrastructure and LPs it is fine to invest and currency returns capped by a strategy, so GPs will keep rais- excellent management and are likely to con- are attractive. A lot of local investors are ing different types of funds and maximise tinue to perform. They are not commodity now becoming more international which their businesses. orientated or cyclical. is reducing the potential volume of capital available domestically for GPs. Over the Bigger funds means increasing com- Are LPs concerned about a turn in the next few years, GP headcount in those petition for assets. How are LPs cycle? markets will be inhibited because it’s very responding to rising prices? Let’s have a reality check. The industry difficult to finance them. Are investors a little nervous about invest- is structured to work through a cyclical One of the few markets breaking that ing at higher multiples? Of course they are. transition. What would damage the industry mould is China: the local headcount of Do they want to dig in a bit more into is a dramatic event, a war, or the unex- private equity firms financed exclusively the operational and risk profiles of private pected financial collapse of a major country by Chinese capital is really high. It is also equity firms? Yes they do. Are the regula- or financial institution. Unless there is a seen in the South Korean and Japanese mid- tors doing that also? Yes they are. Investors large unexpected drop, people are going markets but not at the same scale as China.

44 private equity international december 2018/january 2019 KEYNOTEKEYNOTE INTERVIEW: INTERVIEW: MVISION J-STAR

But the volume of domestic capital invested dealing in local currency, with investors similar regulatory conditions. That’s why a locally is particularly pronounced in China. that understand the local market. lot of the investment programmes convert As a GP, you have to be very focused on to a mean. making investments that will generate cash If I’m a new LP, from Asia say, how do and put you within a range of your global I compete for allocations? Are direct and co-investors at risk peers, as well as demonstrate your strat- For GPs in demand it is complicated. come a downturn? egy, internal governance and discipline. The Imagine 80 percent of LPs want to re-up Mega-investors can’t put enough money to benchmark is a challenge for the emerging with an incredibly popular manager and work in third-party vehicles and they have managers right now. increase their allocation by 1.5 times to find solutions. in aggregate. The space for new capi- Over the past few years there has been Can international GPs also access tal becomes very limited. Even more so a discussion about investors not having the these pools of capital? with European funds that only scale up by infrastructure to match a GP. But they are Absolutely. GPs are targeting these markets. 30-50 percent. You have to introduce an now hiring people from GPs all the time. In the next five years we are going to see a LP early – one or two years before a fun- Remember, direct investments from inves- lot of new capital specifically from northern draising. US public pensions have a short tors are quite conservative – reputational Asia, Japan in particular – Japanese pen- list of firms they will review in two years’ risk is a very big focus for them. Also they sion funds are all between $1 trillion-$3 time. Also, most investors have decided to are becoming more specialist. They have trillion in size and they are allocating 2-3 have fewer GP relationships: 40-60. When huge amounts of capital with a lot of dis- percent to alternatives, which is going to I first started it was more than double that. cipline and experience, governance and move to 5-6 percent – and also markets All these dynamics can create huge access infrastructure and are able to weather such as Taiwan and South Korea will be issues for investors. a turn in the cycle with their long-term more prominent. There’s a good volume of horizons. capital coming from these countries and a What do you do if you can’t get in? lot more to come. When the Chinese pen- The appetite for co- and direct Does the focus on going direct sion and insurance companies become more investing is increasing substantially. It’s dampen LP interest in first time funds? international, there will be a huge amount become part of portfolio construction. In the US, LPs have been very good at of capital moving into the global market The largest Asian investors are very sensi- creating “emerging manager” programmes place from pension funds and insurance tive to the construction of their J-curve, so and allocating funds to first time funds. companies. they will use secondaries and a combina- Their favourites are spin-out teams. If One of the things you need to decide tion of primaries and directs to manage they can access a team from one of the as a GP is whether you’re going to open an it. This new capital has a significantly big firms who are launching a fund and office for investor relations in the region steeper J-curve than I’ve ever seen in my going down the investment ladder to go up or not. Also, LPs have opened up offices in career. They are in the money in very short again, investors love that, especially from London and New York to address access. times. When I first started in the business, popular funds. But outside of the US there The GPs can reach them in these offices, it would take 12-15 years for people to is limited support for first time funds or but they still need to be very conscious of work through the J-curve and arrive at infrastructure for it. At the other end of the local regulations. a good place. As a result, historically, US spectrum, the more remote your market In a market where there is a significant capital is so prominent because those LPs is, the more likely it is the government local investor community, as a local GP my have been through multiple J-curves. The will kick in or development finance insti- decision is how much non-local money to Japanese investors in particular have caught tutions. In between, it’s quite difficult. For accept if any. A domestic GP in Japan, for up super-fast. They can see what everyone European first-time funds, for instance, it’s example, might as well get financed 100 else has done. Investors are all hiring the more challenging and most support comes percent by Japanese investors. They are same consultants and lawyers and they face from the US investors. n december 2018/january 2019 perspectives 2019 45 PERSPECTIVES 2019 | SURVEY RESULTS: FUND TERMS

MANAGEMENT FEES Picking up the tab

Fees remain a bone of To what extent do you agree Have you asked for greater fee contention for limited that fees charged by private transparency and disclosure from partners, as fund sizes equity funds are difficult to justify your GPs in the last 12 months? continue to grow, writes internally: Claire Coe Smith 2.4% 1.2%

34.5% 16.7% 33.3% Management fees remain the biggest bone of contention for investors during due dil- igence with managers, according to PEI’s Perspectives Survey 2019, and are rising up the agenda as fund sizes grow. In all, 45 percent of respondents pointed to management fees as the most conten- tious terms raised during negotiations on the limited partnership agreement, and 46.4% 65.5% advisors say this is not surprising. Strongly agree Yes “Fee negotiations tend to follow a well- Agree No trodden path,” says Jason Glover, invest- Disagree Unsure ment funds partner with law firm Simpson Strongly disagree Thacher & Bartlett. Management fees are Source: Private Equity International Source: Private Equity International typically expressed as a percentage annual levy on funds committed. “First-time funds are usually at 2 percent, and then thereafter Which three LPA terms cause the most disagreement with GPs when tend to find an equilibrium at about 1.5 conducting funding due diligence? percent, especially for the mega-funds,” says Glover. Management fees 45.2 “The area of contention arises when Unsatisfactory/no key man clause 44.0 you are looking at increasing the size of Performance fees 35.7 the fund, with some investors querying why doubling the size of the fund means the GP commitment 33.3 total amount of management fee should also Structure of carry distribution waterfall 33.3 double, when the manager is not necessarily Hurdle rate 26.2 doubling headcount.” Investment restrictions 26.2 Nearly two-thirds of the investors sur- veyed (65 percent) have asked their GPs for Lack of clawback provision 21.4 greater fee transparency and disclosure in Set up costs 16.7 the last 12 months, with 63 percent agree- Board representation policy 10.7 ing that the fees charged by private equity funds are now difficult to justify. Percentage of respondents Mounir Guen, chief executive of Source: Private Equity International

46 private equity international december 2018/january 2019 placement firm MVision, says: “For me, the debate isn’t so much on the quantums when it comes to fees, but on the visibility of the underlying cashflows, and how they are cat- egorised relative to expenses, fees and other costs of investment. “Where GPs spend a lot of time in discussions with investors is on fund size, and what the fund size means for the posi- tioning of the strategy. There’s then a fairly interesting discussion to be had around resourcing relative to that positioning, and it is worth noting that US private equity teams are typically much smaller relative to the quantums they are investing than their European counterparts.” Nick Benson, investment funds partner with Latham & Watkins, says there are also recurring issue. Glover says: “Key person is frequent bilateral conversations to be had always an issue, and it becomes an increas- around fees: “Often big investors will feel ing focal point in the market as investors they should get a particular deal given their become more keen to back institutional size and strategic importance.” brands, which tends to drive a much Second to fees, investors pointed to broader key-person test than might pre- unsatisfactory or non-existent key-per- viously have been the case. Investors now son clauses as a hot topic in LPA discus- often want to see a broader bunch of people sions, with 44 percent saying these were a named, and then there is negotiation around trigger events, remedy periods and so on.” The area of A third of the LPs pointed to the GP contention commitment as an issue, with investors arises when you focused on general partners having ‘skin in the game’ by committing their own money are looking at increasing to a fundraising. Again, this becomes more the size of the fund, with of an issue as fund sizes grow, with GPs typi- some investors querying cally asset rich but cash poor, and therefore constrained in their ability to commit. why doubling the size of Guen says: “The investors would typi- the fund means the total cally like the GPs to be at 2 percent of total amount of management committed capital, but not all managers can meet that – some funds can do a lot fee should also double more. That’s an area where there are sen- Jason Glover sitivities.” n december 2018/january 2019 perspectives 2019 47

KEYNOTE INTERVIEW: BRG

MATURE FUNDS Extracting liquidity from tail-end assets

The secondaries market is an efficient way to restructure What should these fund managers maturing funds, but managers and LPs may need to and their LPs do in the current envi- ronment ahead of a possible downturn? consider other options, say Finbarr O’Connor and Gavin FO: If I am the private equity owner or Farrell of BRG’s Alternative Investment Advisory group asset manager, I would be beginning to think in terms of stress tests at the asset level. What happens if prime goes above 6 What are the alternatives to liquidity for Why haven’t these smaller maturing percent (where the Fed seems to be headed mature funds that are struggling to access funds been able to take advantage within 12 months), and what does that do the secondaries market? Finbarr O’Connor, of the secondaries market? to portfolio company performance and leader of BRG’s Alternative Investment Advi- FO: A theme we encounter is the existence cashflow alongside a dip in sales or activity, sory, which specialises in the management of some form of structural issue either at the or if something happens to global trade or and resolution of tail-end fund interests, portfolio level or at the GP level that may in the Middle East? I think understanding and Gavin Farrell, its director of business prevent many smaller funds from executing how those, or similar assets, performed in development, discuss the options available. a restructuring or outright secondary sale. prior downturns, as well as assessing the For example, we have dealt with situations impact of any leverage constraints, should What are your views on the current where the GP is out of the carry and lacks form part of the investor’s cushion analysis. state of the private equity market, any real incentive to lead a restructuring, particularly as it relates to maturing funds? or where the portfolio assets are distressed Gavin Farrell: We believe the private equity Finbarr O’Connor: The wave of capital that and only deemed attractive to deep discount market is approaching an inflection point, was raised by PE funds between 2003 and buyers. We’ve also had mature situations if it’s not already there. There are decisions 2008 has been maturing. Currently it is esti- where there are consent issues or legacy that are going to present themselves to LPs mated that approximately 25 percent of the litigation preventing transfers on residual in terms of liquidity or the rolling over of PE fund universe has reached maturity. assets. mature funds. There will be a portion of As these funds mature, GPs need to Today, we’re dealing with some older that mature fund market that may not be assess the available options and which of funds facing a range of these sorts of issues. either possible to roll over or restructure in these are in the best interests of their LPs. Some have assets that require time for us a traditional way. Or it may not be in their A significant portion of the mature fund to work through asset level changes or best interests that a traditional approach be market will go through a restructuring restructuring and exit plans. But there’s followed. Not many GPs, or LPAs for that process, facilitated by the strong appetite often a reason mature fund assets haven’t matter, contemplated end of life scenarios and creativity within the secondary market, been exited – those assets are either unat- when the funds were being established and and deliver LPs with liquidity or subsequent tractive or need attention. For the potential there are now alternatives to a secondary investment options. buyers of such assets, it comes down to a sale, but that alternative doesn’t necessarily However, this is not always feasible or balance of the ability and attention required mean accepting the status quo. As Finbarr indeed may not be the best option for LPs. to resolve the structural issues, a pathway to mentioned, some GPs aren’t in a position Some maturing funds, particularly those liquidity and also pricing. So, smaller tail-end to complete an orderly wind down. Others with distressed, out of favour or small funds and assets tend not to be attractive may be very good GPs with a very solid remnant positions may be unable to attract to a wide community of buyers in the sec- business, but the time and effort required decent bids from the secondaries market or ondaries’ market. LPs of those funds can be to focus on winding down a late-stage fund the GPs may be struggling to raise capital left with limited options. If I’m an LP in that may not be the best use of their talents for a continuation fund, so LPs are left with situation I am looking for a plan to deliver when they could be raising a new fund or the status quo – ie, a GP with no incentive liquidity with someone who will be focused managing existing portfolio assets on behalf and an investment with no end in sight. and drive execution. of their LPs.

48 private equity international december 2018/january 2019 KEYNOTEKEYNOTE INTERVIEW: INTERVIEW: J-STAR BRG

when it comes to fund restructurings is what are the exchange terms and how to avoid any conflicts of interest. The SEC has rightly scrutinised these transactions in the past few years. Likewise, the Insti- tutional Limited Partners Association has promised to issue guidance to its members on the topic in 2019. In any exchange of value, there’s a potential for conflict and a potential for a breakdown in trust. It can be an extremely complex process to provide liquidity optionality to LPs that will also satisfy the LPs that want to stay invested. O’Connor: many mature funds will be Farrell: GPs lack incentives restructured Five years ago, fund restructurings were almost unheard of. Therefore, as a relatively How does BRG fit within the sec- sale, a secondaries fund transaction or a new form of transaction, a success factor is ondaries market? collection of asset sales, and then a distri- that the process be well documented and FO: We see ourselves as complementary to bution to investors. Of the mature funds communicated to LPs. other participants in the secondaries market. we’re managing currently, we are work- We do this in two main ways. In the past we ing through a fund restructuring on one, GF: In a GP-led restructuring, you are have worked alongside secondary buyers to while the other funds are at various stages transferring assets from one fund to assist with the management and optimisation in the secondaries market or in direct asset another that is being partially funded by a of troubled assets that have been acquired sales. The largest fund we manage is a hedge new set of LPs. There is no actual realisa- as part of a secondary deal. Secondly, as a fund with illiquid private equity style assets tion event, therefore you’re determining replacement manager, we are an alternative where we’re working through to a delib- the value of a portfolio and transferring a to a secondaries transaction where we take erate asset-by-asset exit process returning portion of that value to the second fund and on the fiduciary responsibility for manage- capital as we close transactions. providing liquidity to some initial investors ment of an orderly run-off and wind-down with the other. It’s critical that there’s an process and distribute capital back. LPs and How can you ensure such transac- independent opinion of value provided to GPs introduce us when they are looking for tions are LP friendly? confirm the fair value of that portfolio of a plan to deliver liquidity and someone to FO: As I mentioned, we are economically assets, and that this is well communicated who will be focused and drive execution. aligned with LPs, but in addition to that we to the LPs. We devise a plan for each remaining port- operate with complete transparency and Furthermore, among the LPs, there’s a folio asset to optimise value and drive the communicate openly and regularly with LPs real sensitivity around the reset of carry. process to deliver liquidity to the LPs. As to ensure that they are fully informed at LPs rarely object to sharing the upside our compensation is linked to the value of all times. We see this as a key pillar of our with GPs when they get paid. But when returned capital, the approach is completely fiduciary duty to LPs. Good stewardship there’s a restructuring they will be likely aligned with the interests of LPs. begets more stewardship and, as a result we to pay close attention to fee terms and have repeat institutional clients that view when transparency is lacking, suspicions Can you describe different paths to us as a practical solution to work through and concerns can grow. At all times, there liquidity? their tail-end interests. must be a clear alignment of interests and FO: Liquidity can come in the form of a One of the things that is, of course, full transparency to avoid any conflicts of fund restructuring, a secondaries asset a hot point with both the SEC and LPs interest. n december 2018/january 2019 perspectives 2019 49 PERSPECTIVES 2019 | LP VIEW

TEXAS MUNICIPAL RETIREMENT SYSTEM ‘We don’t make tactical bets’

For Texas Municipal Retirement System’s director of our portfolio, meet all our hurdles, we will private equity Christopher Schelling, identifying the put $500 million out. If we don’t, we will under-pace. good managers is the easy part – the challenge comes in securing consistent access at scale. By Isobel Markham Will private equity continue to hold up when the market turns? How has your private equity portfo- We’re mostly small market and lower Because of how the asset class is priced, lio performed? mid-market. We have some mid-market, it will absolutely hold up better, at least We have had a good run the last couple of we’ve got one or two large market, but initially, it just won’t get marked down years, it’s exceeding our expectations over we’re not trying to make a market capitali- as fast. I understand that is merely an every metric and over every period. Our sation call. We’re trying to find less efficient accounting factor, but as far as its portfo- three-year performance is 17 percent and segments, lower-priced and more sector lio impact, the vast majority of public plans our one-year is 35 percent. A lot of that is specialists with stronger consistency of and endowments will actually get benefit just the fact we’re in a strong equity market returns, and we’re finding that more often from being there. Now, there are areas that in general and we’ve gotten some strong in the small market and lower mid-market. I think might have bigger drawdowns than performance from a couple of funds, so it’s others, and there are areas where there will early yet I think for TMRS, but we’re defi- Is the impending market correction be opportunity to deploy capital, so we’re nitely pleased with the performance so far. affecting your investment decisions? trying to figure out ‘what happens if’ rather We’re looking at sector specialists – we try than make predictions. I think the most How is your portfolio split? to be bottom-up in building this portfolio. If overheated market segments are the ones We’re around 90 percent US, 10 someone comes to market who’s the best at that are going to be hit the hardest, that’s percent international. By what we consider what they do and we can invest, we would not a stretch to say. market exposure – NAV plus unfunded invest there, we would not make a tacti- commitments – we’re 50-55 percent cal sector call. But at the margins, we’re Given the current strength of the buyout, 20-25 percent growth and venture, trying to find exposure to managers that fundraising market, are you seeing but most of that is in growth equity, and do things that are less cyclical and should managers return to market earlier than then we’ve got another 20-25 percent in have more stability in their top line, and expected? special situations, which is basically mez- we’re also thinking about how managers We’re seeing several funds come back a lot zanine and distressed. performed during the last downturn. We sooner than we thought, and that impacts want to avoid really beta-heavy funds that pacing. It also means your capital’s going to maybe had a great fund before, a great fund be put to work less quickly, which is an issue after, and did terrible during the downturn. when you’re trying to get to target, so that We would prefer someone who maybe over does concern us, although we understand time doesn’t have the highest numbers but the reasons for it: investing is lumpy, and did well before, preserved during and has all of our funds go through a little dry spell continued to do well after. We’re thinking and then at some point most funds will have about distressed because that is an area to three or four deals close in a very short deploy capital when the rest of the world period of time. If the general partner is blows up. But as far as tactical bets, we don’t saying, “We need to have capital available make them, and we’re not changing our so we can continue our franchise because pacing model, we’re trying to be consist- we’ve got two or three deals that are going ent. If we want to do $500 million and to close,” it’s not my job to tell them they’re Schelling: plenty of opportunities to go round we find great managers who complement wrong.

50 private equity international december 2018/january 2019 PERSPECTIVES 2019 | LP VIEW

We’re seeing several funds come back a lot sooner than we thought, and that impacts pacing

What we want to see in that situation if who source, we have consultants who work many people chasing how many opportu- we’re going to commit is that they don’t turn for us, we see a lot, so I don’t think any public nities and how many dollars behind that. on the fees until the other fund is done. There pension team that’s got a $2 billion private The number of opportunities is going are ways you can make that less of a conflict. equity portfolio will tell you it’s so hard to up because there are more and more pri- If you’re only 45 percent in the ground and identify good managers. But the problem vate companies and fewer and fewer public you still have two years left of your commit- with putting out so much money is get- companies, so you can have more managers. ment window for the prior fund, you do not ting enough in the ground relative to your I think we’re still a long way from the private get to turn on fees on committed until the resources to monitor that portfolio. market being anywhere near as efficient as other one is done, period. That would be the public market, at least in some parts. non-negotiable. But we would still commit We’re seeing a lot of spin-outs. Is You’ve got 15,000 mutual funds, you’ve if they would structure it appropriately. there still space in the market for got hundreds of thousands of traders and new managers? investors, you’ve got 10,000 hedge funds, For high-performing managers, is I think there is still space. We also see some and you’ve only got here in America 3,500 access an issue? spin-outs from shops where there is not publicly traded companies, so that’s super- Access is an issue. In private equity I don’t going to be a subsequent fund, so it’s not efficient. You’ve got 400,000 private com- think identifying good managers is tough, adding to the number of managers in the panies that have EBITDA between zero and really, at all. Getting access to the best con- space. I think there will only be an increas- $50 million-$100 million, so that’s a deep sistently and in scale to move the needle for ing number of managers, and at some point pool. Is 10,000 too many? I don’t know, but a large portfolio, that’s more of a challenge. there will be too many. My concern then I think for private equity, 2,000 in market For large public pensions, all of us have a isn’t necessarily the number of managers, year-to-date, there’s plenty of opportunities ton of capital to put to work, we have people it’s really the efficiency of the market – how to go around. n december 2018/january 2019 perspectives 2019 51

KEYNOTE INTERVIEW: PARTNERS GROUP

IMPACT INVESTING Making an impact

Impact investment is on Responsible investment practices have What’s your view on the difference the rise, with the increased come a long way in the last decade as between ESG and impact investing? investors increasingly seek ways of creating I see this as a spectrum rather than binary, involvement of more value and mitigating risk through an envi- so you have a continuum of ESG, investing mainstream players in this ronmental, social and governance lens. Yet according to the SDGs and impact invest- part of the market. Partners many are also looking for ways of making a ing. This spectrum is simply a reflection of Group’s Kevin Lu discusses positive impact through their investments the genuinely different ways for investors how their entry is changing across a variety of measures, from promot- to monitor the impact of their investments. ing gender equality and reducing poverty You have to consider that there are differ- the market through to mitigating climate change and ent types of investors and fund managers protecting human rights. For many, this has – you have smaller, niche impact investors been made easier by the creation in 2015 of that focus on a very specific geographic the United Nations’ Sustainable Develop- or thematic area and then there are more ment Goals, an articulation of 17 goals for mainstream investors that cast the net sustainable development, as they provide much more widely and invest much larger a framework around which investors can amounts of capital. Overall, I see respon- focus their impact investment efforts. sible investment as the umbrella term that The growth of impact investing is clear. covers this spectrum and it’s a space that has In its 2018 annual survey of impact inves- evolved – and continues to evolve – from, tors, the Global Impact Investing Network for example, the broad set of principles set says that the latest “best available ‘floor’” for out in the UN Principles for Responsible the size of the impact investing market is Investment through to more specific ways $228 billion, a marked increase on the 2017 of achieving impact. figure of $114 billion, with respondents So, for example, we monitor ESG fac- expecting to increase the amount of capital tors for all our investments, we involve our they invest by 8 percent over the coming ESG and sustainability team and implement year. Private equity, given its concentrated ESG initiatives in all our lead and joint-lead shareholder model and corporate govern- investments and we have our PG LIFE strat- ance features, is one of the main benefi- egy that has a specific impact mandate and ciaries of this move and it’s therefore no focuses on investments whose products and surprise that some of the industry’s biggest services directly support the SDGs. players have now raised impact funds. Earlier this year, Partners Group estab- It can be a bit like alphabet soup for lished a specific impact strategy, PG LIFE, the uninitiated – to what extent do which aims to achieve market-rate financial you think there’s still confusion around returns as well as positive social and envi- some of these terms? ronmental impact by investing in line with I don’t think there’s confusion about the the UN’s SDGs. We caught up with Partners outcome, whether that is simply improv- Group’s Kevin Lu, partner and chair of PG ing ESG performance or achieving deep LIFE’s impact committee, to explore the impact, but there is still definitely some growth of impact investing and what effect confusion around what people are talking the entry of mainstream investors will have about and that’s a function of the space still Lu: onus is on LPs to vet impact offerings on this part of the market. evolving. People label what they’re doing

52 private equity international december 2018/january 2019 KEYNOTE INTERVIEW:KEYNOTE INTERVIEW: PARTNERS GROUP J-STAR

How do you see the impact investment market devel- for part of your portfolio, you need larger vehicles in which oping in the future? to invest. You also need the comfort that you are investing I see an evolution of the niche, thematic players as they with an institutional platform with well-defined processes, grow. These are highly targeted strategies and you have a lot rather than with a few people with a lot of passion. And once of philanthropic capital directed at this space. At the other these larger players develop a track record, I think you’ll see end of the scale, you’ll see more large, commercial players more LPs allocate to impact investment programmes. I guess emerge to meet investor demand for impact investment at the question of how the market will evolve remains in the scale. This makes sense from a capital deployment perspec- middle part of the market – it’s difficult to know whether tive – if you’re a large LP and you have an impact objective these players will gain any traction in the impact space.

differently and there is no standardised last few years, it has started to enter into Ten years ago, definition of each of these terms. the collective mindset of LPs and these days, impact was a However, I’m not concerned about the if you don’t think about impact, you are an lack of a standard definition because the outlier. For its part, the industry has been nice-to-have. bigger question is whether we are now innovative in offering LPs impact products. It was niche. Yet over reaching an inflexion point for ESG and For example, we’ve seen impact funds being the last few years, it has impact investing. The fact that more main- raised by some of the largest private equity stream players are developing products firms over the last two years and this has started to enter into the and offering investors a means of access- enabled LPs to access products that help collective mindset of LPs ing impact investments has to be a positive them meet their impact as well as return development. The fact that people are gen- objectives. erally more responsible investment-minded There’s also an element of larger man- suggests that the direction of travel is good, agers realising that they have made such it’s just that different players are trying dif- investments in the past, just without the ferent ways of developing ESG and impact. intentionality of making them “impact investments” per se. These products reflect What’s driving more mainstream increased deliberateness in how to evaluate, impact strategies? measure and own these same companies It’s a natural evolution: 10 years ago, impact with impact goals in mind. was a nice-to-have. It was niche. Yet over the And then there are the generational ›› december 2018/january 2019 perspectives 2019 53

KEYNOTE INTERVIEW: PARTNERS GROUP

If you’re a large dealflow and that allows them to be highly for the sake of standardisation can actually LP and you selective. Our strategy, for example, is to be counterproductive as it can give a false invest through our impact programme only sense of objectivity. You have to make too have an impact if a transaction has also met the criteria many assumptions if you try and quantify objective for part of your for our private equity, real estate or other impact in IRR or multiple terms. portfolio, you need larger programmes. However, this places the onus on LPs to You have to consider that a big part of understand what separates a robust impact vehicles in which to invest an impact methodology is to introduce for- methodology from a superficial one. This ward-looking monitoring. You put in place should start with simple questions: what KPIs for management based on what you is the manager’s definition of impact? How want to achieve from an impact point of do they screen and evaluate investments for ›› differences – if you’re an LP, your con- view, so if you’re building a solar park, for impact? Beyond monitoring and reporting stituencies are changing. There is far more example, you have to think both about how outputs, what processes are in place to truly focus on impact among younger genera- it will reduce greenhouse gas emissions, manage for impact? tions and so LPs investing on behalf of these but also how the business will responsibly Proper LP vetting will certainly help generations have to take this into account. dispose of batteries and protect local bio- assess impact strategies, but I think many These differences also affect investors from diversity, among other things. If you inject managers will be wary of entering the a staff perspective. When I’m hiring millen- this type of forward-looking mindset into impact investing space without a robust nials, for example, it’s clear that they think companies and you define impact objec- methodology. The potential cost to brand very differently about their careers than tives effectively, there is a multiplier effect. and reputation is too great if they get it junior employees did just 15 years ago. It’s If you own the largest renewable platform wrong. no longer about how to maximise earning in a country, its practices will affect other potential; it’s much more about what their renewable platforms in that market and Private markets are in some ways a career means to them. perhaps even beyond. This is the promise natural home for impact investment, of impact at scale; the potential to have but to what extent do you think there is What would you say to those that a systemic impact on the “mainstream” scope for growth in the public markets suggest the entry of more main- economy. space? stream players will dilute impact investing? Yes, private markets have a big advantage There will always be those who equate an To what extent can LPs assess and in impact investing because their models industry reaching new levels of scale with compare impact methodologies and allow for much greater control of the dilution, but, in the impact investing space, I measurement, given the lack of stand- transaction throughout its lifecycle – pri- think the reverse is true. The vision of most ardisation? vate equity firms can own and influence a impact-minded investors is to see the con- If you’re looking at the financial aspect of portfolio company’s strategy. Public markets cepts and values of impact investing reach whether the strategy makes money, that’s are, by their nature, much more indirect – scale. This cannot happen without leading quantifiable and therefore easily compared. the same goes for fixed income. I’d ask the investment managers carrying across these When it comes to measuring impact, there question of whether there is a way of having concepts and values to larger, more main- is no standard way of reporting, despite a minority shareholding but still a big say stream assets, and doing so with the govern- a number of initiatives. For example, the in corporate governance. Public company ance rights to deliver meaningful impact. IFC’s Operating Principles for Impact Man- governance tends to be more inefficient, And if you want to achieve impact at agement, which are an attempt to prevent so if there was a means of injecting the scale, there also have to be platforms that dilution of impact investment and offer tighter, more direct governance seen in pri- can be commercial and that achieve the some clarity on what it is, are still concep- vate markets, that would be a huge boost to financial returns that investors are looking tual. That’s not a criticism, it’s a statement the impact investment industry. The public for – you can’t ask them to sacrifice returns of fact – Partners Group was involved in the and fixed income markets are so large that or they will look elsewhere. Mainstream initiative. And I don’t think it’s a problem if this issue could be resolved, it could be investors have access to large amounts of because moving towards standardisation transformative. n

54 private equity international december 2018/january 2019 PERSPECTIVES 2019 | SURVEY RESULTS: ESG

ENVIRONMENTAL, SOCIAL AND GOVERNANCE Taking the responsible road Only one-third of LPs describe ESG as a major consideration, but that doesn’t tell the full story, pension funds say. By Victoria Robson

For managers feeling the pressure from LPs However, David Russell, head of respon- to deploy more time and resources in the sible investment at the UK’s largest pension To what extent do you believe your pursuit of environmental, social and govern- scheme by assets, USS Investment Manage- GPs’ investments reflect your ESG ance policies, the rather muted LP inter- ment, described this reading of the results policies? est in ESG captured by PEI’s LP Perspectives as “perhaps a little too simplistic”. 5.3% 18.7% Survey may come as a surprise. “What this means is that the majority For about a third of LPs, ESG is a “major [of LPs] will put some emphasis on ESG 8.0% consideration” in fund due diligence, with in fund due diligence and that would seem the remainder reporting ESG issues were to be a positive step forward compared to of minor or no concern at all, while two- the past. There is obviously still some way thirds believe GP investments reflect their to go, but there is a definite growth in the ESG policies only “somewhat”. Just 19 per- number of LPs assessing ESG risks in their cent report their ESG outlook was strongly private equity investment,” he says. 68.0% aligned with manager practices. USS has developed a responsible investing questionnaire that it sends to all potential GPs and scrutinises new GPs’ GPs’ investments strongly reflect my ESG policies track records on ESG issues. It is critical, GPs’ investments somewhat reflect my ESG policies GPs’ investments hardly reflect my ESG policies however, that LPs continue to monitor ESG GPs’ investments do not reflect my ESG policies at all

activities post-investment to gain assurance Source: Private Equity International policies are being implemented but also to signal that the LP takes this issue seriously, Russell says. How much emphasis do you place The definition of ESG continues to on environmental, social, and stretch. “What LPs are demanding of GPs governance issues throughout fund [in terms of ESG] continues to grow”, says due diligence for private equity? David Jeffrey, partner and head of StepStone Global’s European business. “It really mat- 39.2% 15.2% ters to us because it matters to our end investors.” However, one impediment is the absence of tangible data on the contribu- tion of ESG to returns. “We’re still on a journey within the world of private mar-

kets to be able to provide the empirical 45.6% data that is required to show responsible investment can add value,” Jeffrey says, noting that it falls to the LP community ESG is a major consideration as a whole to standardise due diligence ESG is a minor consideration so managers can prove that they are good ESG is not a consideration corporate citizens. n Source: Private Equity International december 2018/january 2019 perspectives 2019 55

KEYNOTE INTERVIEW: SANNE

CONSOLIDATION Who gains from the fund admin M&A boom?

Given the wave of Nothing makes a fund administrator hap- when Bank of New York merged with takeover activity among pier than an overwhelmed CFO looking to Mellon Financial in a deal worth $16.5 bil- fund administrators, we sat get something off their desk, and given the lion. Fund administration offerings of big increasing demands from LPs and regula- banking institutions are a complementary down with Jason Bingham tors, plenty of service providers are probably addition to their other core services. And of SANNE to discuss what giddy. It’s also created a boom in the industry it makes a certain amount of sense that a it means for GPs shopping and that’s translated into major M&A activ- bank that’s already offering lines of credit for service providers and ity. Apex and SS&C alone acquired three and other banking products would offer companies each by August of this year fund administration as part of their one- the future of his industry already, and major private equity firms, stop shop solution to access GPs. including The Carlyle Group, have added But having worked in that large bank fund administrators to their own portfolios. environment, the reality is that their offer- But what does this mean for the quality of ing comes with a fairly rigid service model service? When a service provider merges with that isn’t necessarily conducive to small to a peer or acquires another business, does it medium-sized fund managers. Some banks always mean clients get more bang for their may have minimum criteria requirements buck? Or does it mean there will be hiccups, that can be hard for them to meet, and as the service provider hunts for those syn- if the GP needs something beyond their ergies? And how can a GP tell the service standard service offering, they’ll be a price provider will be there when the boom ends? to pay for that. We spoke with Jason Bingham, the man- The credibility of a big banking name for aging director of product development at LPs can be attractive to GPs, but that brand SANNE, a FTSE 250 fund administrator and that big balance sheet can come with listed on the London Stock Exchange, to get limitations, in terms of service offering. And some answers. And what he suggests is that some banks don’t have the risk appetite for GPs should pay attention to the ownership some of the fiduciary requirements that are structure of their administrators. As service part of servicing private equity firms. providers merge, acquire or find themselves At the other end of the spectrum are the with new owners, there will be an impact smaller local players that have real limits to to their service capabilities, both positive the jurisdictions they serve and size of funds and negative. But the current landscape they can handle. Investment in technology suggests that in a few years, this industry and managing their own growth can prove could consolidate into a handful of larger, challenging, which makes them prime tar- elite professional firms, which may end up gets for acquisition. a net positive for their clients. Then there are offshore law firms that offer a fund administration component as How should GPs look at the wave a complementary service. Such work pro- of M&A activity in the fund admin- vides steady annuity income and sticky istration business? relationships that only strengthen their legal They should understand that a service operations. But at some point, the size and

Bingham: SANNE’s listing has brought greater provider’s ownership structure matters. complexity of that business can often exceed transparency M&A in our industry dates back to 2006, their appetite for investment in more people

56 private equity international december 2018/january 2019 KEYNOTEKEYNOTE INTERVIEW:INTERVIEW: SANNEJ-STAR

and improved technology. Which leads them It provides comfort and credibility to There will to be targets for acquisition as well. LPs and GPs. In terms of governance, the always be standards for a listed company are very What about the fund administrators high, which is certainly an advantage to us. smaller niche that are owned by private equity It’s a badge of honour to be on the LSE, and providers, but the global firms? GPs seem bullish on the space, at challenges our unlisted peers to find ways players will be better least as portfolio companies. to match that. The access to capital mar- They are, and I believe they see an attractive kets also makes it easier to manage growth. placed to meet the market, where a buy-and-build strategy is We’re able to attract more talent and have increasing demands of an able to generate value and increase their the capital to invest in our service offering. international client base returns. But from a fund manager perspec- tive, there’s the inevitable exit strategy. And Say a GP’s service provider gets that means making decisions based on a scooped up by a larger peer. What finite timeline and ways to drive perfor- should they know about that transaction mance in the near term. That may well to understand if, and how, their service may How do you see the M&A landscape mean reducing costs, which can result in change? in your industry in five to 10 years? a leaner organisation or less investment They need to understand the rationale What does the future look like? in new technology, which may reduce the for that transaction. Our acquisitions We are of the view that in a few years there overall quality of service. are around giving us a new jurisdictional may be a situation similar to the ‘Big Four’ The desired ownership structure for us presence, or a new product. For example, accounting firms, where the industry con- is the listed one, which we are. We went we acquired a hedge fund administration solidates into a handful of key elite profes- public on the LSE in April 2015 and I have business in 2016, because we never had sional players. There will always be smaller to admit, I had my doubts about competing the capability in that area. However, if an niche providers, but the global players will with privately owned firms. Our competi- administrator is acquiring a competitor in be better placed to meet the increasing tors would know a lot more about us due to something more akin to a merger, that’s a demands of an international client base. the transparency requirements that come different story. The commercial rationale Only the most innovative and customer led with being a public company but that trans- for a merger involves the presumption of organisations will survive. All those PE firms parency has actually given our customers synergies, which can often mean lengthy will be looking to exit these investments greater insight into our business, which is integrations that potentially take the focus in our industry, and that means a potential a good thing. away from client service or require adapta- IPO or selling to a strategic buyer, which tion to a new system. And GPs rarely enjoy ends up feeding that consolidation trend. doing either. But the upside is that clients will enjoy Here’s a way to look at M&A activity in that competitive environment, as we’ll be This industry our space. Is the transaction driven by the competing with each other to provide could priorities of the administrator’s owner, or by them with cutting edge technology, high the demands of clients? All our acquisitions standards of governance and solid, reliable consolidate into are driven by what our clients need, which relationships. n a handful of larger, elite is high visibility in multiple jurisdictions, professional firms, which across several complementary product lines. And that means we’ve acquired businesses SANNE is a leading global provider of alternative may end up a net positive asset and corporate business services to the world’s in new places or that cater to new products largest asset managers, global financial institutions for their clients – this adds real value to clients. and international corporates december 2018/january 2019 perspectives 2019 57 Edited by Tony Ecock, The Carlyle Group the operating partner in private equity Volume 2 Advanced strategies for value creators

content highlights:

• Dan Colbert discusses how The Riverside Company built and refined its operating approach with key lessons for achieving success.

• Scott Glickman, Dan Soroka and Sara Boyd of Graham Partners outline a programme for proactively identifying and reducing business model risks.

• Mark Gillett of Silver Lake Partners and David Moss, an independent adviser, provide a framework for assessing and implementing transformational versus incremental change.

• Sandy Ogg of The Blackstone Group, proposes three action points for ensuring the portfolio company CEO search and selection process is successful.

• Matt Sondag of West Monroe Partners provides useful tips for how to select and optimise the emerging role of the IT operating partner…plus much more

available now Order your copy today:

 www.privateequityinternational.com/op2 London: +44 (0) 20 7566 5444  New York: +1 212 937 0385 Hong Kong: + 852 2153 3844  [email protected]

special offer to subscribers: Order your copy today quoting SUBBK15 and receive a 15% discount PERSPECTIVES 2019 | ESG

DIVERSITY Gender inequality in the crosshairs

Under-representation of women can have serious consequences in private equity, writes Alex Lynn

Finance has long had an embarrassing diversity problem, and private equity is no exception. Women account for just 14 percent of partners at UK private equity firms, hedge funds and other financial services part- nerships, according to Financial Conduct advisor Cambridge Associates, told Private New UK legislation requiring businesses Authority data analysed by law firm Fox & Equity International in September, noting with more than 250 employees to report on Partners in September. Progress is being that some LPs will take a step back if not pay differentials between men and women made, but the pace is glacial; the figure enough has been done to tackle the issue. provides an – albeit limited – glance at the stood at 13 percent five years ago. “If [some of our clients] don’t see suf- state of play. Diversity is front of mind for a growing ficient levels of diversity and inclusion, or Blackstone’s UK business paid male staff number of investors – a trend underscored well-intentioned and meaningful efforts to bonuses that were on average 75.4 percent by the Institutional Limited Partners Asso- build towards a team and organisation that more than those received by female col- ciation expanding its due diligence ques- has more diversity of personnel, they will leagues for the 12-month period to April tionnaire to include general partner-level make an investment decision fully incor- 2017. Men earned 30 percent more than diversity issues and giving guidance to GPs porating that information.” women on an hourly basis, compared with on the establishment of codes of conduct A deficit in workplace diversity contrib- the UK national average hourly pay gap of for “defining, reporting, investigating and uted to heavyweight managers Blackstone 9.1 percent recorded by the Office for disciplining harassment, discrimination and Group and Brookfield Asset Management National Statistics. violence in the workplace”. being passed up for a $50 million infra- The firm explained the gap by pointing The changes to the DDQ include a structure allocation by the $10.8 billion to the fact close to three-quarters of its template for GP firms to measure and Chicago Teachers’ Pension Fund in June, male employees are investment profession- report the gender and ethnic diversity of sister publication Infrastructure Investor als, and these roles typically attract higher their teams by seniority and role, as well reported. rewards than non-investment roles. It said as a new section that aims to enhance a “Blackstone and Brookfield are still chal- less than a fifth of its female employees are limited partner’s understanding of a GP’s lenged with some diversity issues. And while investment professionals. policies and procedures in areas such as they’re working on it, they’re just not there But Blackstone is something of an hiring, promotions, family leave, mentoring, yet,” CIO Angela Miller-May told II. exception: it’s unlikely that many, if any, harassment and discrimination. “We want to make sure we make the other UK private equity houses will have “[Diversity] is a question that we are right decision that’s going to protect the enough staff to qualify for the reporting asking GPs all the time given the under- assets of the pensioners and at the same legislation. ILPA’s questions should help, representation of women and minori- time we want to be responsible with our but for now, gauging progress, or a lack ties in the private equity realm,” Andrea investing, making sure we’re investing with thereof, on diversity is likely to remain a Auerbach, head of private markets at LP diverse and inclusive managers.” challenge. n december 2018/january 2019 perspectives 2019 59 PERSPECTIVES 2019 | QUOTABLES

SOUNDBITES From the mouths of LPs

Whether it was on how to prepare for a downturn or on the challenge facing mega-funds, LPs had plenty “Having 5 percent to to say in 2018 7 percent to alternatives is meaningless because of the fees… I don’t have a magic number but it’s not worth dipping a toe in” “What we are Sandra Robertson, CIO of Oxford University Endowment Management “If the market was to trying to do now is naturally evolve, I think really to batten down it probably would have operations of our “The sheer happened already” portfolio companies” bite-size to come David Enriquez, interim co-head Olivia Ouyang, director of funds in and actually move the of private equity at New York City and co-investments at Ontario Employees’ Retirement System, on Teachers’ Pension Plan, prepares needle for these funds how the 10-year limited partnership for the next downturn is going to be a very is here to stay interesting challenge” Christopher Ailman, COO at CalSTRS, on the “The superior challenge of deploying “We need to take giant funds results of Yale and advantage of the most a number of peers strongly attractive timing to invest, suggest that active and we cannot do this if management can be a “If we’re right then we are too scared, or there’ll be disappointment powerful tool for institutions we lose the courage to that commit the resources experienced by those continue investing” involved, and then to achieve superior, risk Katsunori Sago, CIO at Japan Post adjusted investment results” Bank, on keeping up the pace opportunities will re-emerge Yale hits back at Warren Buffett’s of investment and we’ll be back” suggestion that endowments Matt Clark of South Dakota should adopt a passive Investment Council on indexing strategy why they are pulling “It is imperative back from PE the council be able to “Selling a company out analyse exactly what we are paying for those of one fund and buying it in “Private equity is a very investments and to ensure another, even when a third heterogenous asset class that those costs are accurate party leads the transaction to and if you can’t access and appropriate from a risk/ establish the value, is simply world-class managers return perspective” a huge conflict for GPs who you shouldn’t do it, have broad discretion” New Mexico State Investment Council on why it hired a fund Christopher Schelling, director of you’re better in the services firm to validate the PE at Texas Municipal Retirement public markets” fees it pays GPs System, on a “concerning” A spokesman for Church new trend Commissioners

60 private equity international december 2018/january 2019 INSIDE THE FUND MANAGEMENT FIRM How to build and deliver operational excellence

Edited by Karen Sands of Hermes GPE, this compelling new title from PEI offers thought leadership on the key issues facing private fund firms, and usable best practice on how to navigate through them to deliver operational excellence.

CONTENT HIGHLIGHTS:

• Integrating ESG issues into the firm and investment processes. • Blue Wolf Capital Partners recounts its operational growth story • How to get the best operational staff onboard • Navigating the new data regulation minefield • Practical guidance on building cyber awareness • Outsourcing intelligently – when to do it and how to manage the relationship with third parties • LPs want evidence of operational AVAILABLE NOW best practice – discover the Order this book today processes, information and documents they’ll be analysing

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