The industry's reputation for innovation and creativity has propelled PE forward as it drives value creation and business transformation in the companies it owns.
PE working closely with LPs to adapt to their changing needs
GPs have also become more focused on ensuring adequate alignment of interest with their LPs. More than 240 GPs have endorsed the ILPA principles which have issued a series of guidelines to help frame discussions with GPs around fund terms and conditions. In addition, GPs are increasing their reporting and transparency to LPs.
This trend reflects the limited partners' more rigorous fund manager selection processes, less capital available for new commitments as distributions have materialized more slowly than anticipated and a desire to reduce the number of GP relationships they manage.
Yet LP needs have changed in other ways, too. In recent years, they have become more strategic in the deployment of their PE allocations. Previously, allocations to PE might have entailed selecting managers at the upper, the middle and the lower ends of the fund size spectrum, with some regard to geography, LPs now require increasing granularity over their asset allocation decisions as they seek to manage their investments and risk more effectively, with some even targeting specific sub-asset allocations.
LPs have also become more focused on ensuring adequate alignment of interest with their GPs. The clearest demonstration of this has been the formation of ILPA, which has issued a series of guidelines to help frame discussions with GPs around fund terms and conditions.
PE has responded to these trends in pragmatic and entrepreneurial fashion, with the result that LP allocations to PE are set to continue increasing over the medium to long term. Investors view PE as a vital means of achieving strong risk-adjusted returns. Over the last five years, allocations by most major investment types have trended higher.
Average allocations by pension funds increased from 4% to 5% and those by endowments rose from 8% to 12%. These proportions could rise further as increased public market volatility and a continuing low interest environment impact LPs' overall returns in other asset classes
Proactive engagement with LPs
To allay investor concerns on alignment of interest, there appears to have been some movement in favor of LPs on terms and conditions in areas such as management fees: average fees dropped from 2% in 2008 to 1.71% in 2011, according to Preqin. And, in a bid to attract investors at first close, some funds such as BC Partners and EQT Partners have offered "early bird discounts" on fees.
Yet there has not been a wholesale shift in terms. Instead, in recognition of the partnership between LPs and GPs that is the foundation of PE, sponsors have proactively engaged with investors and sought to meet their individual needs. As LP portfolio management has increased in its sophistication, GPs are developing alternative ways to work with their larger LPs, including providing more co-investment rights.
Some are also establishing separate accounts for LPs, which provide large investors with more control over their committed capital. Partnerships such as those agreed between The Blackstone Group and the New Jersey Division of Investment and KKR and the Teacher Retirement System of Texas are two such examples.
These developments demonstrate both the staying power of the industry and how adaptable the PE model can be as they address the needs of the LPs. They help investors boost returns through direct exposure and offer them more control over their investments. They also provide additional capital to GPs at a time of lower credit availability and offer an alternative to club deals, which can be difficult to execute successfully.
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