Why the private equity downturn could be a boon for certain LPs
The resilient private equity industry wasn’t immune to the broader downturn last year. But even as the PE fundraising environment gets trickier, some insiders see pockets of opportunity—especially for certain limited partners.
Jill Shaw, a managing director of endowments and foundations at Cambridge Associates, which builds portfolios and advises LPs, argues that the downturn could actually bode well for certain LPs with cash to spend in PE funds. That’s because some more sought-after PE fund managers are already more open to accepting new LPs into their funds as their longtime investors may be overallocated to the asset class and therefore pulling back, says Shaw.
That overallocation has been the case for many LPs, even as of early last year, and is due in large part to what I and others have been talking about a lot lately: the denominator effect, where because of the poor performance of assets like stocks, the portion of LPs’ capital in private equity has become outsized. “Some investors are going to pull back [and] are pulling back, so access to some really great managers is becoming more available,” Shaw recently told me.
In other words, “There’s a little bit of pain on both sides, which provides an opportunity for investors that aren’t feeling that pain to step in and take advantage,” as Shaw puts it.
Shaw told me of a middle-market PE firm that, when raising their seventh fund recently, was taking into account the “environment we’re going into,” and said, “‘We think it’s going to be hard for us to raise this fund.’” She says Cambridge Associates was able to get a “lot of new access for our clients,” and predicts we’ll see more opportunities in the next year. However, since many managers already raised a ton of capital in the past year or so, they likely don’t need to go to market right away, Shaw points out—though they may return to raise in the second half of next year.
If you are a lucky LP who’s able to take advantage of such an opportunity, Shaw warns that you need to be talking regularly with the fund managers so you could be one of their first calls.
If you can get in, now could be a historically good time to invest: Drawing on data, Shaw notes that recession-era vintages (those funds that start deploying during a downturn or recession year) have historically outperformed. That’s logical, of course, since you’re buying in at a discount and can ride the wave up when the economy starts to recover.
The upshot is that from the LP perspective, this could present an opportunity to “upgrade their manager roster and get exposure to what should be better performing years,” Shaw says.
Which types of managers are most in demand right now? Well, according to PitchBook data, the mega funds (those with $5 billion or more) brought in the lion’s share of funding in 2022—with 13 vehicles raising nearly $179 billion, or 52% of all fundraising dollars (in the U.S.). Think the likes of Blackstone. But Shaw argues that the “hot” funds are the “ones that have generated really strong outperformance…and that really has not been the mega-cap funds” by and large. Instead, she’s seeing the most promise in emerging managers or those that may “have spun out from one of those tried and true funds and hung their own signal and started their own funds,” says Shaw. She argues many of those harder-to-access managers, and the ones that may present an opportunity, are the middle-market PE firms with around $3 billion or less.
However, authors of a recent annual PitchBook report on U.S. PE write that while some LPs may look to diversify with emerging managers or specialists, as LPs grow stingier with their allocations, “many are being forced to prioritize certain relationships over others, and the victor is typically the larger funds with proven track records and established relationships spanning sometimes multiple decades.” The PitchBook authors still expect mega funds to dominate fundraising in 2023 as they did in 2022.
Either way, if you’re an investor with cash to spend, you might want to ready your PE fund shopping list.
See you tomorrow,
Jackson Fordyce curated the deals section of today’s newsletter.
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