The relationship between limited partners (LPs) and general partners (GPs) has continued to evolve in recent years, as niche strategies – such as co-investment and secondary transactions – have become more widely adopted. A panel of LPs and GPs examined the pros and cons of these trends at the 2015 Michigan Global Private Equity conference on October 9. The event was sponsored by the Center for Venture Capital and Private Equity Finance and the Zell Lurie Institute at Michigan Ross.
Co-investment Goes Mainstream
“What we’re seeing over the last three to five years is that a lot of LPs are trying to get more co-investment,” reported Eric Hanno, a principal at AlpInvest Partners, a global private equity firm with an integrated investment model and $48 billion in assets under management. “Many LPs use co-investment as a fee-reduction strategy.” AlpInvest creates synergistic opportunities for its business partners by providing fund commitments or supporting the timely execution of co-investment or secondary transactions. The firm plays the co-investment role broadly ─ from participating in a syndication to teaming up as a co-sponsor early in the process and actively supporting underwriting a bid.
“Co-investment is beneficial for both LPs and GPs because it deepens mutual understanding and strengthens partnerships,” said Eric Wilcomes, director and portfolio manager at DuPont Capital Management, which offers proven investment management services and global perspective to institutional investors. “LPs have an opportunity to see how a GP works in more detail, and a GP is able to solidify the relationship with investors.”
“Despite the favorable economics, co-investment is not for everyone,” said Brian Gimotty, director of investments at the UAW Retiree Medical Benefits Trust, which provides health care benefits for retired UAW members of General Motors, Ford and Chrysler along with their eligible dependents. “Co-investment takes a lot of time, and not all LPs can do it,” he continued, “These days, more LPs are bringing on additional talent, because they need a different skill set for co-investing.”
Secondaries Are Overheated
Another trend, according to the panelists, is the rapid growth and mainstreaming of the secondary market, which focuses on the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds. Stricter U.S. banking regulations and tighter oversight in the U.S. and Europe are compelling banks, funds, insurers and other institutions to pare down or sell off assets. Impatient limited partners also are opting to sell their interests in PE funds early to receive liquidity for their funded investments as well as a release from any remaining unfunded obligations. Many private equity and global investment advisory firms have set up specialized teams or programs dedicated to the origination, structuring, execution and monitoring of secondary transactions in the private equity and hedge fund markets.
“Secondaries are now part of portfolio management, and there is no longer a stigma attached to selling off positions,” Gimotty said. “Secondaries also make an illiquid market more liquid. However, most LPs don’t have the skill set to execute these acquisitions.”
“We place the most weight on the quality of people,” Hanno remarked. “If we are buying a secondary portfolio, we want to make sure we have the best people as partners. It’s not just about the deal. You can buy great assets at a discount, but what you do with these assets is how your create value.”
“A lot of players have come into the secondary space, and it is now very competitive,” Wilcomes reported. “These secondary buyers have a lot of money. Therefore, discounts have shrunken because so much money is chasing secondaries.” In the past, GPs looked unfavorably on secondary transactions, which resulted in the sale of LP commitments to unfamiliar investors. “Now it happens so frequently and fluidly that GPs accept it and use it as an opportunity to get to know new investors,” Wilcomes added.