IPEM Paris 2024 - The Daily Spin - MONDAY, SEPT. 9th

LPs were in the spotlight with the LP-Only Sessions, sponsored by GOLDMAN SACHS ALTERNATIVES, BPIFRANCE, SCIENTIFIC INFRA & PRIVATE ASSETS, with our content &  research partners CAIA ASSOCIATION, ILPA, and IPC.

They took the stage to learn more about the new trends emerging that will over time become the foundations of sustainable growth.

LPs sticking with private markets but return dispersion expected to widen

IPEM Paris 2024 kicked off with a bang amid a flurry of vibrant discussions and networking for the exclusive “LP-Only” sessions. 300 old acquaintances and new faces from 50 countries gathered at Le Meridien Hotel for an afternoon of sessions on the evolving landscape of private equity. This year’s theme of “Forging Confidence” centered on understanding LP needs and addressing crucial issues amid a market characterized by significantly lower distribution rates and higher interest rates; yet no clear sign that valuations had fallen.

While private equity is regarded as a cyclical asset class the last few years have been interesting precisely because there has been no cycle to speak of. Monetary policy has been largely responsible. Having enjoyed a halcyon period, where private equity returns boomed and rates were near zero, the 500 basis points of rate hikes changed everything. Although there are signs that rate cuts will soon begin, it will still take three or four years for things to normalize.

The good news is that this is an excellent time for liquid providers, with PE secondaries projected to reach $150 billion in 2024, alongside the rise of continuation funds and hybrid capital. High selectivity in continuation fund investments was emphasized, presenting portfolio financing as a viable liquidity solution for LPs. On average, distributions as a percentage of total NAV have been 20 to 25%. These are down to mid-single digits. There’s a big backlog to clear and if the IPO markets warm up this should improve the exit environment.

For now, LPs are choosing to cash in and take capital off the table. As was noted during the LP-only sessions, the take-up rate for continuation vehicles is 90% as GPs need more time to drive further growth in selective assets. Not that secondary investors are being any less discerning or selective. It was noted that only around 10% of continuation funds that Goldman Sachs Alternatives looked at last year ended with an investment. Investors are looking for a 15% value discount and are being careful to ensure the quality of asset is understood and that the right partner in the firm is running the asset. A continuation fund does not guarantee the returns will be strong.

Return dispersion is something that investors expect to see widen over the next decade. GPs will fall by the wayside in the aftermath of the rate hikes.

Nevertheless, there was a clear feeling at IPEM Paris 2024 that GPs still have leverage over LPs; the pendulum has yet to meaningfully move in their favor (aside from perhaps the world’s largest institutions). LPs spoke candidly about the need for smaller LPs to continue to ask GPs for better terms. Just because a GP hasn’t been asked to do something doesn’t mean they shouldn’t consider doing it. If they know that 10 smaller LPs have said they don’t like a term, a larger LP can go back to the GP and say ‘We’re not coming in to the fund unless you change it’. This can go a long way compared to if said large LP had initiated things and the GP responded, ‘Well, you’re the only one asking for it’.

There are other ways for LPs to leverage better bargaining power with panellists suggesting:

🟠 Securing co-investment rights

🟠 Looking for Most Favored Nation clauses

🟠 Asking for more substantial key-person clauses, which have weakened substantially

The clearest gripe that LPs have is poor transparency and reporting with one LP noting that the information asymmetry that arises makes it hard for investors to build confidence and commit future capital. An audience poll found that 66% of the room cited poor transparency and reporting, with 37% citing GP discretion over fund extensions.

Some LPs did note that in the last five years things have changed. “We are getting more [transparency] from top quartile GPs than we’ve done in the past and certainly regulation is pushing a lot of this.”

SEC regulations calling for more transparency on things like partnership expenses makes the poll result slightly surprising. As one large US allocator mentioned, it is perhaps incumbent upon LPs to ask themselves whether they really need so much information and whether there might be a more efficient way forward. Too much transparency can bring its own set of problems.

There was no clear consensus on whether LPs would pay higher fees to a GP who is more transparent in their reporting. Factors cited included:

🟠 Proper alignment of the GP; i.e. 15% of the fund’s assets

🟠 Strength of the underlying performance of the team

🟠 A belief that the value creation strategy is repeatable on a go-forward basis

Paying a carry premium is not an easy discussion but based on the above factors, not necessarily something LPs would say no to.

“Are they generating most of their returns from one or two investments? And how does that trend over the fund life? There’s a whole host of terms you can negotiate that you identified during due diligence,” remarked one LP.

With contributions from Cyndi Mosquera, Roger Vincent, and Rune Jepsen, delegates learned about the management of significant assets under management (AUM), focusing on primaries, co-investments, and emerging managers achieving notable performance.

The discussion highlighted performance trends indicating that tech-focused and smaller companies outperformed larger counterparts, prompting a shift from IRR to DPI metrics for liquidity considerations amidst rising private market allocations by limited partners. From a risk perspective, it was said that a well-diversified PE portfolio is no riskier than investing in public markets; i.e. an equity beta of 1. Private markets can still deliver 300 basis points of illiquidity premia. With an average public market return of 7%, private markets should be capable of generating 10%+ annualized returns.

It was noted that the challenge of investing in emerging managers – from a benchmarking perspective – is that the data is limited requiring more of an assessment of absolute returns in the historical track record “and as much as you can, trying to get a sense of future return potential”.

One LP observed that investors can do interim benchmarking and find out if their 2019 fund compares well with all other 2019 funds in 2023. “But that’s not going to tell you anything about whether the fund, on a long-term basis, will have a good outcome.”

With the need for liquidity, DPI has become more important than IRR when thinking about performance. There is a sense that some GPs feel they can’t go out and fundraise until they’ve had an exit from the fund. That’s a net value destroyer to LPs who are calling for GPs to deliver distributions because what ends up happening is the GP sells a good quality asset two or three years too early.

LPs are taking vintage diversification into their own hands. During the LP-only sessions panelists referred to the need for LPs to pace themselves when investing in private markets to avoid cash flow negative (<1.0) situations. It’s not like distributions aren’t there, they’re just not there as much as certain LPs are looking for.

“Some investors got over-excited and over-allocated to private markets. Putting pressure on GPs for DPI…this cycle will happen again and it’ll probably involve retail investors,” observed one investor.

The issues of impact washing and green washing were also discussed. Intentionality is key. If there is no passion and the investment manager demonstrates no sentiment in how they present their fund strategy…that is the worst thing to do. Investors want to see alignment, they want to see commitment; both human and financial, formal and informal.

The feeling was that there are many opportunities to apply private equity to this area of investing, “the market is there” said one LP.“ It is a way for GPs to generate a green premium at exit if they invest in businesses that put them in a stronger sustainable position.”

One GP also emphasized that green washing is most susceptible to performance exaggeration. However, by emphasizing the fund’s purpose and its objective and focusing on the business of measuring outcomes, it’s hard to exaggerate operational uplift. “We are looking for a demand factor driven by a societal challenge,” remarked one GP. By helping a company to grow and enjoy commercial success, the impact it has is the reason for the commercial return.

Panelists noted that if GPs find themselves having to make big assumptions that is when a bit of humility needs to come in.

To wrap up the afternoon a series of polling questions were shared with the audience where it became evident that across private markets as a whole, LPs are more keen to stick than quit.

Some 37% of LPs said they plan to “slightly increase” their allocations to private equity over the next 24 months, with 24% voting for “significantly increase”. Mid-market growth and buyout strategies, and PE secondaries, are the most compelling strategies for LPs right now, garnering 50% and 48% of votes (multiple selection). Some 45% of LPs said they were active in the secondary market and were planning to execute in future, with 31% confirming that they plan to within the next 12 months.

Only 6% of LPs are focused on re-ups with existing managers. A far greater percentage, 64%, said they were balancing re-ups with allocations to new managers. When asked what their thoughts were on the use of continuation vehicles, the audience proffered a range of adjectives, with “Opportunistic” and “Useful” coming out on top.

So ends the first day of IPEM Paris 2024. See you all today for another packed program of discussions.