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Most Private Equity LPs Not Ready For Economic Downturn

A vast majority of North American and Asian LPs – 80% and 70 % respectively - believe that their private equity portfolios are not prepared for the next economic downturn and that they need adjusting to weather that storm, according to private equity secondaries investor Coller Capital’s latest Global Private Equity Barometer, a twice-yearly survey of international LPs in private equity funds.

European LPs, however, take a different view. Less than half – 45% - of them believe that they need to adjust their private equity allocation.

“There is an interesting geographical divergence in the findings” said Stephen Ziff, Partner and Co-Head of Investor Relations at Coller Capital’s London office. “Europeans believe that they are more prepared. They might be more sanguine – or it could be because Europe has already begun to see a slowdown.”

The survey results also suggest that the explosion in private debt fundraising in the past 5-10 years could be about to plateau. Whilst 21% of the survey respondents said that they would increase the pace of their commitments to private debt, 21% said that they will slow their commitments.

“The landscape for private debt is changing, likely in anticipation of an expected economic slowdown” said Ziff.

Perhaps unsurprisingly, LPs think public criticism of the industry has become louder in recent months, a view likely fuelled by U.S. Senator Elizabeth Warren’s attack on the industry and her ‘Stop Wall Street Looting’ act, which would make significant changes to the way the industry is governed stateside. 69% of North American LPs feel that this criticism has grown louder, but three quarters of all LPs globally believe that the trade associations in the various jurisdictions could do more to promote the benefits of private equity.

“Our survey results suggest that there is more to be done here” said Ziff.

One area where, in the coming years, private equity could be forced to make a positive change – or, at least, a perceived one – is in ESG investing. 38% of LPs say that they are planning on reducing their exposure to private equity oil and gas opportunities, and 40% say they will increase their allocations to renewable energy investments and 42% say they will put more money into general climate-friendly products and services, as a response to climate change.

“ESG is becoming a greater area of focus. Understanding what the GP is doing and how they are implementing ESG policies is becoming critical to LPs. Investors are moving investments to areas where they have greater influence, so transitioning away from heavy industries like oil and gas towards more climate friendly investment opportunities” said Ziff.

Another theme in the private equity industry to emerge post crisis is the increase in LPs looking to co-invest with their GPs. Some 70% of LPs already co-invest, and almost half – 44% - are pro-active in seeking out these opportunities, up from one third in 2012. Indeed, 36% of large LPs prioritise GPs who can offer these deals. The benefits are numerous for those that can get it.

“Coinvesting enables LPs to drive down their entry price into private equity. Secondly, it enables them to be overweight or underweight specific sectors or geographies. The opportunity for private equity access on a fee free, carry free basis is definitely appealing for larger investors” said Ziff.

Whenever the next downturn hits, however, almost all LPs expect to see a significant divergence in performance between GPs and between funds.

“We have experienced one of the longest stock market expansions in history,” said Jeremy Coller, Coller Capital’s CIO, “but investors know that winter is coming. They are telling us that differences in the quality of managers’ strategies and teams will again lead to a significant divergence of returns between GPs – just as it did in the GFC.”