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In the face of rampant LP demand, should private equity firms worry about the industry’s wider reputation?

FRIDAY LETTER

Mar 16, 2018

Beware the PE echo chamber

In the face of rampant LP demand, should private equity firms worry about the industry’s wider reputation?

More good news for PE this week: investor appetite just keeps on growing.

A full 95 percent of investors surveyed by advisor and placement agent Rede Partners plan to maintain or increase their private equity exposure in the next 12 months. Rede’s ‘Liquidity Index’, which gives a directional view on sentiment towards the asset class, shows investors to be more positive about co-investing, new relationships, distributions and their existing manager relationships.

You may not have fallen off your seat in surprise at this news.

We’ve grown used to hearing about institutional investors wanting more, whether through research – as per our own LP Perspectives survey – or through the fact of funds being oversubscribed. This week we caught up with Equistone Partners Europe to discuss its sixth fund; the firm held a first and final close on €2.8 billion and scaled back a further billion in demand.

When you operate up close and personal with the industry, you get to read the studies that back up its success and see the returns generated by the institutions that have accessed it.

The private equity Kool-Aid is tasty; there is no shortage of investors ready to testify to its returns-generating power. We have recently been spending time with Alaska Permanent Fund, which is carving its own niche in private equity to great effect. You can read about the fund’s unusual private equity programme here next week.

However, if you step outside of the private equity bubble the reaction to the asset class can be sobering.

Last week Private Equity International attended the Pensions and Lifetime Savings Association Investment Conference, a long-running gathering in Edinburgh at which figures from across the UK pensions industry – trustees, asset managers and investment consultants – swap notes on everything from LDI to ESG.

A lot of UK pensions have not yet been at the Kool-Aid. The word ‘opaque’ was frequently used by delegates to describe the private equity industry, despite the efforts of limited partners, private equity managers and regulators. Hidden fees and a lack of transparency over the financial engineering carried out on portfolio companies were two commonly cited problems. One pensions advisor and executive board member zoned in on deceptively worded clawback clauses, which in her view fail to stop fund managers accruing more than their fair share of fees. She told PEI: “Many trustees are not clued up enough to see they’re being shafted by PE… A lot of investment advisors are clueless as well.”

It's worth noting that comments from a handful of disgruntled trustees are not representative of the future health of the asset class, but they should be on the radar. As Wol Kolade, managing partner of mid-market firm Livingbridge, noted in a recent video interview with PEI, private equity is currently “pretty insignificant” in terms of the investable universe and if the industry wants to take advantage of investor demand, it needs to scale. He notes that the largest sovereign wealth fund in the world – Norway’s giant Government Pension Fund Global – does not yet invest in private equity.

Should private equity firms be worried about the industry’s wider reputation? If the industry is to go truly mainstream then indeed they should. But while investor appetite looks like it is going in just one direction – up – they probably won’t.

Write to the authors: toby.m@peimedia.com and rod.j@peimedia.com