The Changing Face of Limited Partners: Investors, Allocators, Competitors

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By Alex Rohr, Merion Investment Partners

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The Changing Face of Limited Partners

Reports of larger and faster fund closings, compressed fundraising cycles, the impact of GPs selling their stakes, increasing role of ESG and the importance of diversity and the divergence of GP/LP interests were topics that highlighted the changing LP landscape.

Featured Panelists:

  • Tom Danis; Managing Partner/Co-Founder, RCP Advisors LLC
  • Travis Escobedo; Director of Fundraising, NewSpring Capital
  • Jackie Rantanen; Managing Director, Hamilton Lane
  • Sheryl Schwartz; Managing Director, Flexstone
  • Colin Dinneen; Managing Director, FIRSTavenue (moderator)

 

The Dualing Narrative Surrounding the Current Fundraising Environment

News headlines continue to report larger and faster fund closings.  However, Hamilton Lane data shows fundraising hovering at the same levels for the last two years.  According to Jackie Rantanen, Managing Director at Hamilton Lane, while investors have a lot of choices and some GPs may raise quickly, the market isn’t as frenzied as it might seem.  From the perspective of Tom Danis’, Managing Partner and Co-Founder of RCP Advisors the fundraising market is robust and has existed at a plateau for 5 plus years with no change on the horizon.  Sheryl Schwartz, Managing Director, Flexstone has been investing in funds since 1997 and believes the key difference with this cycle is growth on the demand side from a lot of new entrants like sovereign wealth funds, retail investors or high net worth individuals.  Meanwhile the existing players are increasing their allocation percentages. 

Competition for allocation exists on both sides and the use of technology and data is key.  Other tactics for fighting for allocation include building and maintaining relationships and networking with a constant presence in the market.  Engagement is also important which includes getting the attention of the decision makers.

Compressed Fundraising Cycles

Travis Escobedo, Director of Fundraising, NewSpring Capital sees a highly competitive fundraising market with GPs returning to market more quickly with larger fund sizes, making LP new allocation decisions highly selective. In his opinion, the main driver is the increased velocity in the market: distributions from GPs drive LPs need to re-deploy capital. Increased efficiency in the market and leveraging of technology is enabling GPs to put the money to work more quickly. A robust deal environment, better data and increasing efficiency keep the cycle moving.

From Rantanen’s perspective, the overall time frame for funds coming back to market has not compressed to the levels seen in 2007 where it was as few as 2 or 3 years between fundraising.  Hamilton Lane’s data shows current cycles closer to 4 years apart and while exceptions always exist, overall, managers appear to be showing relative restraint in this area. 

Danis believes GPs are fundraising more quickly because they recognize we are in the later stages of an economic cycle.  GPs want to secure capital for their next fund now, before the next economic downturn.  Some funds are so quick to raise they have no exits to show from the current fund.  In this case, Schwartz’s advice is to evaluate whether the current fund is executing on its initial strategy, i.e. have the GPs stayed true to their intentions for number of deals, deal size, pacing, strategy & industry, valuations, sourcing, team size and retention, and key metrics of the current portfolio are positive.

Impact of GPs Selling Stakes

It is hard to know for sure the impact of GPs selling stakes because it is a relatively new market that has yet to fully evolve.  Schwartz admitted it is a concern to LPs when GPs sell, but it is becoming more common in the asset class and so LPs will have to learn how to manage.  Suggestions included evaluating the impact of the GP sale on ownership, governance, behavior, alignment and uses of the proceeds.  LPs are more tolerant in scenarios where the sale is non-voting and minority. 

The Increasing Role of ESG and the Importance of Diversity

ESG awareness is increasing for LPs in the US.  According to Schwartz, ESG and governance is a core part of European LP fund underwriting.  They won’t invest in a fund or co-invest alongside unless both their underwriting criteria and ESG criteria are met.  Escobedo echoed the same sentiment saying ESG is more top of mind in Europe then it is in the US.  Danis added that European LPs have very specific demands.  While ESG risks are also business risks and the implementation of ESG policies aren’t complicated or abstract, a lot of funds struggle with simply where to start.  But once implemented, funds realize the pursuit of outsized returns isn’t at odds with ESG. 

Diversity in a fund is important, especially in fundraising.  Both LPs and GPs alike are becoming more diverse and like sitting across the table from each other and seeing mirrored diversity.  Diversity is also top of mind for recruitment and investment in portfolio companies.  The ability to recruit high quality talent is difficult and it can be hard to find diverse candidates.  Firms can invest in building networks and better recruitment processes to find the most talented and diverse candidates.

Is there a Divergence of GP/LP Interests?

Capital calls and the use of lines to artificially boost IRR Metrics, the extension of fund life and secondary sales and fund succession are all current issues that are creating conflict between LPs and GPs.  Danis points to an asset class that is maturing where innovation and liquidity are creating that conflict.  While some bad actors can spoil the pot, in general, he believes most GP and LP issues are resolved constructively.  Rantanen agreed that the evolution of the market can at times mean competing priorities, but pointed out it is in both parties’ best interest to work through those areas and end up on the same page.