Some of the most influential investors are giving the world’s largest private equity firms a message: if you want money for your next fund, here’s our list of demands.
Sovereign wealth funds and state pension providers are among investors telling money managers they’ll only commit in their upcoming fund raises if their capital tied up in old funds is released, according to people with knowledge of the matter.
Additional requests range from fee discounts and more co-investment opportunities, to greater information rights and representation on committees, the people said, asking not to be identified because the requests are private. Some are even asking for a cut of the fund’s management fee or an opportunity to buy a stake in the fund manager, the people added.
“We’re now undergoing a real cultural change,” said William Barrett, managing partner at Reach Capital, a private-market fundraising firm. “It’s the first time we’re seeing LPs being so straightforward and linking a distribution from one fund to a new commitment in another. They’ve never been so precise with their asks.”
The relationship between private equity firms such as Blackstone Inc. and Apollo Global Management and their backers is symbiotic. Large fund managers cannot scale their platforms without money from the biggest so-called limited partners, while the investors need managers with the capacity to accept large swathes of capital.
But the balance of power is shifting within the $8 trillion private equity industry as buyout funds struggle to return money to investors amid disagreements between buyers and sellers over corporate valuations. That’s handing more power to LPs to dictate the terms of engagement.
As money rolling into private equity slowed last year, the heft of a handful of funds who make the majority of investments into private markets — such as sovereign wealth funds from the UAE, Saudi Arabia, and Qatar — has become even more persuasive.
Just five years ago, funds from the Middle East didn’t make the top 10 state-owned investors of private markets, according to data from Global SWF. By 2023, five were from the Gulf — including Abu Dhabi’s ADQ and ADIA.
In some circumstances, funds including ADIA and Singaporean sovereign-wealth fund GIC are among investors specifically asking for distributions to be returned to them from older vintages as they discuss upcoming fundraises, some of the people said. To be sure, one person familiar with the matter said GIC makes selective investments into new funds without taking capital from previous vintages.
Other requests from some SWFs include demands for more disclosures about the underlying assets in portfolios, the people said. The investors are asking for more information about their investments than ever before, with demands sometimes coming weekly, some of the people said.
Representatives for ADIA and GIC declined to comment.
US PE exit activity fell to an unprecedented low last year relative to the industry’s horde of capital under management, according to Pitchbook, with the current median holding period of investments exited reaching 6.4 years, the highest in more than a decade. This year’s forecast indicates that buyout fundraising is expected to be approximately 30% below its current linear trend, Pitchbook data showed, while trailing 12-month buyout fund distributions through the first quarter of 2023 hit their lowest level since the global financial crisis, the data said.
“It’s a tough market and LPs are using the leverage they have, particularly the largest investors of private credit, such as the sovereign wealth funds, and state pension plan funds, Barrett said. “Fund managers have to fight for their dollars now and investors know this.”
Investor money
One commonly used justification for LPs asking for cash back is the so-called denominator effect. Where the value of assets from real estate to public stocks have proven volatile in recent years, private equity valuations have largely remained steady — at least on paper.
This has meant that in some instances investors have liquidated private holdings to avoid breaching allocation guidelines designed to safeguard the long-term safety of funds. That’s combined with many institutional investors from Singapore to Canada becoming more conservative.
However, fund managers have been slow to sell fund assets into the current uncertain markets, indicating a reluctance to crystallize asset values that may be lower than expected. Instead, many are using leverage to release funds.
“Historically, if you invested into a PE fund your capital was locked in for 10/11 years,” said Jeff Johnston, head of fund finance at Everbank. “Now there are more and more ways through leverage, and secondary sales to try and get that capital back.”
The strategy of using so-called net-asset-value, or NAV, financing — a loan backed by a pool of portfolio companies — has become more widely used. The loans are typically costly and critics warn they are likely to dilute returns later down the line.
Vista Equity Partners generated $18 billion in total value by cashing in on bets since late 2021, but it still signed a $1.5 billion NAV loan in March last year that earmarked $500 million for investor distributions, according to a person with knowledge of the matter.
A representative for Vista declined to comment.
David Philipp, a partner at Crestline Investors, whose Fort Worth, Texas-based firm provides NAV loans to money managers, said there’s been an uptick in LPs requesting capital back and asking for general partners to explore NAV lending to facilitate a portfolio level recap.
“This is often stemming from a sponsor soliciting the LPs to re-up in an upcoming fund prior to delivering money back from previous vintages,” Philipp said.
Some PE firms are also taking out loans at the management company level to help meet fund commitments.
So-called manco loans are typically backed by assets including the promise of future fee income and can charge interest into the high teens.
Private equity’s increased use of leverage can sometimes come at a cost for other LPs in the fund who haven’t opted for the fund to add leverage, according to Crestline’s Philipp.
“We’ve seen a few cases where the majority of LPs have voted in favour of NAV and the rest haven’t, and they’re then forced to take expensive liquidity,” he said. “That obviously can create some issues unless the minority group of LPs are given an ability to opt out or given an attractive reinvestment option to neutralize the cost.”
As sovereign wealth and pension funds raise their scrutiny and demands over private markets firms including those in the $1.6 trillion private credit market, some are increasingly lending directly to borrowers, and cutting out direct lending giants altogether.
The Canada Pension Plan Investment Board (CPPIB) and GIC — which typically provide funds to private credit giants to deploy — directly offered among the largest portions of a €4.5 billion loan backing Blackstone Inc. and Permira Holdings’ purchase of European online classified company Adevinta in November, Bloomberg previously reported.
“LPs are generally becoming more and more educated in private markets investing,” said Reach Capital’s Barrett. “The next question will be when will some of the biggest backers of this sector begin building their own in-house origination teams and start cutting out the middle man.”
