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LPs commit to PE despite uncertainty, but not all funds reap the benefits

Limited partners continue to commit to private equity funds following the global spread of coronavirus, but not all managers have been beneficiaries.

The bifurcation between funds that are able to raise large sums and those that may face difficulty seen earlier this year continues, although some of the factors affecting certain raises have evolved.

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Virtual fundraising combined with LP rules about meeting managers in person means some funds may be unable to win over new commitments in the short term. Likewise, many investors are attracted to sectors that have weathered the worst of the COVID-19 uncertainty, leaving appetite for those that have not blunted.

COVID-19 "almost accelerated" funds that were advanced in their raisings, with LPs prioritizing re-ups — commitments to new vehicles being raised by their existing managers — in part because no on-site visit was required, U.S.-based co-founder of placement agent Rede Partners Scott Church said. "If anything, existing managers got a lot of attention, probably more than ever between March and May," Church said. This exacerbated LPs' allocation setting, which is usually front-loaded in the first half of the year.

The large-cap private equity market is a beneficiary of COVID-19, founder and managing partner of placement agent Cebile Capital LLP Sunaina Sinha Haldea said, adding there is a "huge demand" for quality private equity general partners. LPs have also been placing larger checks with bigger funds that can manage heavier allocations, so those managers can attract larger fund sizes.

Funds focused on sectors that have performed strongly during the coronavirus pandemic, such as technology and healthcare, are also in demand, as are both distress-focused strategies and pan-regional funds due to their broad geographic remit. Fundraising for these vehicles will accelerate, if anything, in the current environment, Church said, and "take the stage when other people might be running to the corners or waiting."

Hard going

Emerging managers — those new to the market that are raising early iterations of vehicles and seeking commitments from new investors — could find fundraising more difficult. First-time funds launched by managers with an attributable track record, that have an attractive focus, and do not have the additional burden of an existing portfolio to manager could be attractive to LPs, Church said, but overall the bar for these managers is higher.

Established GPs that have neglected investor relations over the past two years will also struggle to launch, although this would have been the case pre-coronavirus, Karl Adam, partner at placement agent Monument Group Inc., said. "You can call up an LP and say, 'Hey, we just launched our fundraising. I know we haven't spoken in three years but do you want to start some virtual due diligence?' and I think the answer in many cases is going to be — you're not at the top of my list."

Some managers that were planning to fundraise in the third or fourth quarter, but whose strategies have been affected by COVID-19 uncertainty, have put these plans on hold until early 2021.

Of these managers, some have opted to launch GP-led restructurings or are using credit facilities to fund new deals, but often they do not need these options, Adam said. "Deal pace has gone down quite a bit now given the sort of bid-ask spread and, GPs probably [have done] fewer deals in the past six months than they expected to," he said, adding that this gives them more runway with their current fund.

Given the uncertainty, managers must be cautious in how they deploy capital, Rede's Church said. Funds that would normally start raising once the current fund is at 65% invested may pause for now. "You're going to have to be even more careful in deploying that remaining 35%, so take more time and come back when the markets are a bit more normalized," Church added.

Bending the rules

Investor capital continues to chase private equity despite uncertainty because "the public markets have ridden up so high in valuation that the yield chasing behavior is coming to private equity when [investors] think that valuations are certainly better than in the public markets," Cebile's Sinha Haldea said.

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In-house LP rules around meeting managers in person to make commitments mean the majority are unlikely to make commitments to managers they've met for the first time over Zoom, but some have been looking at flexible options.

"We've had situations where investors have said, look, we'll do everything we can, but then we need to meet you, even if it's at an airport for 15 minutes. We need to meet you otherwise we can't sign off the check to our board," Sinha Haldea said.

Some investors that are considering additional flexibility view this as a way to be competitive and win places in funds that have been overallocated in the past.

If an LP has been "dying to get [access to]" a particular fund that it has not met with for three years, but there is a window of opportunity, an investor may think "this is my one chance to get in with these guys," and may look to short cut their processes to make it work, Adam said, but noted this is an exception to the rule.

More LPs hope to benefit from being bold while everyone else is skittish — getting into good situations, being flexible with their diligence, and referencing managers with others in their network, Church said, but they remain a minority. "The market's a bit bifurcated in the ones that will feel strongly that they will have to just lean into existing relationships during this period versus another segment that's saying we're going to be more open-minded."