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Private equity LPs weigh trade-offs amid fast fundraising cycle

The fast pace of private equity fundraising is forcing institutional investors in the asset class to weigh difficult choices, even as there are signs the pressure may be letting up.

Recent years have seen private equity general partners returning to market with ever-larger funds at an accelerating clip. The limited partners who invest with them spend more time tending to existing fund manager relationships, creating a backlog of new and emerging managers competing for attention.

Managers of new funds are not just competing against their better-established peers, they are "competing against all the new funds for the last couple of years that we wished we could've invested in," said Roger Vincent, who heads up the private equity portfolio for the Cornell University endowment and was a panelist at SuperReturn North America 2022 in New York last week.

Tough decisions

Michael Barzyk, who deploys about $1 billion a year into private markets as managing director and global head of private equity for Allstate Investments LLC, said opportunities to reinvest, or reup, with Allstate's existing fund managers in 2022 exceeded by 150% his firm's annual allocation to private equity.

"Fundamentally, it means we've got to make a lot of very tough decisions," Barzyk said.

One option, Barzyk said, is to simply pass on a reup and skip a fund. But that decision comes with a cost to vintage year diversification, an investing strategy that evens out the valleys and peaks of macroeconomic cycles.

Another is to reduce the size of the commitment by up to half, which gives Allstate the fund vintage year diversification it is looking for but risks harming its relationship with the fundraising general partner, possibly costing Allstate a shot at coinvestments, Barzyk said.

The third path is to continue deploying capital at pace while paring back the number of funds it invests in.

"I don't know that there's any one right answer, any one right approach," Barzyk said.

Ryan Karaian, investment director at Children's Healthcare of Atlanta Inc., said the pickup in funds coming to market forces institutional investors to go through their roster of GPs and decide "who's going to make the cut." GPs are evaluated on more than just investment returns, Karaian added, noting that one critical factor is the pace at which those GPs are returning to market with new funds.

If they are coming back too quickly and adding complexity to already difficult allocation decisions, "they may not be the right fit," Karaian said.

Unattractive secondaries market

Earlier this year, the accelerated fundraising pace prompted LPs to bring a significant number of large portfolios to the secondaries market, where existing investor commitments are typically traded among private equity firms. Selling investment positions can free up liquidity for LPs, allowing them to invest in new funds.

But Barzyk said Allstate recently explored a small secondaries transaction and found the potential sale price fell well short of expectations because of a glut of offerings in the market.

"I think it's indicative of the amount of product, the amount of supply that's currently in the market today," Barzyk said.

Sean Olesen, an investment officer for the Cornell University endowment, confirmed that pricing for those small secondaries deals is "not attractive." And it might not be advantageous to trade one investment, with all its inherent risk, for another.

"Why sell something that might be a good asset or might just take a little longer to crystallize?" Olesen said.

Fundraising slowdown

There may be some relief coming for LPs as signs emerge that the pace of fundraising is decelerating.

"It is becoming a struggle to raise money," said Shifra Ansonoff, global head of research for Preqin Inc., confirming anecdotal evidence of a slowdown that began emerging earlier this year.

Fundraising in the second quarter was "roughly down 50%" compared to the same period in 2021 in terms of both the number of funds in market and the aggregate total of capital raised, Ansonoff said during a presentation on fundraising. Funds are also spending longer in market, Ansonoff added, noting the portion of funds hitting their target in six months or less is shrinking while the funds spending 25 to 30 months in market is growing compared to 2021.

Karaian added that the fast fundraising pace is shifting the LP-GP power dynamic. His office is "a little more comfortable" pushing back on GPs, knowing that so many of the asset class's other institutional investors are feeling squeezed.

In terms of relative negotiating power, the pendulum definitely swung toward GPs over the past five years or so, Barzyk said, but that is changing.

"I think it's going to start swinging back a little more in the direction of the LP," Barzyk said.