The world of private equity is being shaped by powerful forces including the growth of global investment in alternatives, industry consolidation, fee pressure and a trend among general partners (GPs) to broaden their offerings across asset classes. In combination, these forces have significant implications for GPs, and particularly for those planning to offer a greater diversity of funds, e.g., real estate, hybrid and infrastructure funds as well as private equity investments.
The most fundamental force is the increased flow of global capital. PwC predicted this month that the global private equity market will grow to around $7 trillion in 2020, double its size from 2013, with alternatives as a whole growing at roughly the same rate. This is in line with FIS’ recent industry survey showing that virtually all GPs are considering raising more money in the next two to three years.
Growth is clearly a positive for GPs, but it arrives alongside a more challenging trend: consolidation. Just recently, leading institutional investor California Public Employees’ Retirement System (CalPERS) announced plans to cut the number of asset managers it deals with in order to place greater emphasis on a smaller number of relationships, concentrate investment on the best performers and negotiate better fees by offering chosen asset managers larger chunks of capital. Establishing larger, more influential relationships also enables investors to demand better and more standardized information about their investments – potentially a key differentiator for GPs that can offer this as LPs aim to consolidate.
Together with the expected growth in alternatives investment, consolidation encourages GPs to broaden their investment offerings because consolidating limited partners (LPs) will generally favor GPs that can supply a range of investments, although there are exceptions where specialist GPs should indeed stay focused on their area of expertise. Diversifying also allows GPs to sidestep the conflicts of interest that can arise from launching multiple funds simultaneously in the same investment sector. The result – nearly all GPs in FIS’ recent survey said they are considering offering a broader range of funds with more diversified strategies within the next two to three years (and 57 percent are definite about this).
Multi-strategy GPs will find themselves not only needing to deepen, but also broaden, their ability to satisfy LP demands for information. There’s already plenty of evidence that LPs are keen to drill deeper into their investments – 87 percent of LPs in our recent survey want to increase the amount of monitoring they perform on underlying portfolio companies. The challenge of helping LPs do this is compounded for multi-strategy GPs, many of whom will need to bring together information mined from different asset classes to inform a broader picture. Among other things, this will help LPs understand risk concentrations, e.g., they may have invested heavily through a private equity fund in a company that is also the anchor tenant of major properties in a real estate fund.
It’s not easy for GPs to deliver a “broad and deep” service because each asset class has its own roll call of reporting metrics. For example, in venture capital, early stage funds focus on milestones and growth funds focus more on financial performance, while real estate funds take account of factors such as occupancy rates, key tenancies, and property types. These differences help explain why each asset class has its own specialist investment management systems, e.g., the property management systems used by real estate fund managers. Multi-strategy managers will want to retain these systems but they will need to draw out selected information to build that wider cross-asset class picture.
The combined effects of growth, diversification, consolidation and fee pressure should not discourage GPs from launching new types of funds, but should inform their thinking. Moving to multi-strategy asset management may be the time to make a leap forward in operational efficiency – something that private equity managers have helped many other industries accomplish in the face of market change.
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