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PE fundraising continues apace, LPs take flight to safety in 2019

Despite uncertainty, private equity fundraising was broadly consistent with previous years in 2019, and the long-anticipated market correction did not materialize. In the first of a two-part series, S&P Global Market Intelligence looks at the three biggest trends in capital raising over the past year.

Fundraising continued apace

In total, global private equity funds secured $417 billion in the first three quarters of 2019, up from $345 billion year on year, according to Preqin Ltd.'s third-quarter private equity and venture capital report. But all funds are not equal in the current environment.

Fundraising seems to have peaked and is hovering around similar levels to past years, Hamilton Lane Inc. principal Carolin Blank said. The firm has observed limited partners, or LPs, being disciplined. Blank said she had not seen the "crazy kind of fundraising behavior" that has characterized other peak periods.

Fundraising "is pretty much stuck in a loop at the moment," said Mounir Guen, CEO of placement agent MVision Partners LLP. There is a flight to safety when it comes to portfolio construction, and LPs are looking to consolidate relationships with fewer general partners, or GPs, and deem larger funds "a safer pair of hands." Investors are also looking at costs, performance, and the timing of performance, and both primary and secondary opportunities. "More importantly," Guen said, they have incorporated co-invest and direct opportunities in their portfolio. "The net of all of this, from a market perspective, is there's very little new capital available in the marketplace. It's extremely selective," Guen said.

LPs are also questioning GPs on how they will raise their game and generate sustainable outperformance, said Scott Church, co-founder of placement agent Rede Partners LLP. Firms are increasingly talking about applying big data, data science and information technology to their offerings in a bid to boost performance, as well as other initiatives such as introducing sector focus, or a unique approach to process. "It really tightens up the story if you can convince investors that you have some really unique capabilities there," he said.

GP-led secondaries

GP-led secondaries have risen in 2019, and the practice has shed its negative connotations.

"I think this is a year where this has become a fairly established practice," Elias Korosis, partner at Hermes GPE LLP said, adding that it is something the firm has seen across the board, including for many of its large buyout vehicles. The practice allows GPs and LPs to look at the private equity portfolio in a more dynamic way. For LPs, GP-led restructurings allow investors to take more active investment decisions during the life of the fund. "You don't have to look at it as a buy and hold for 10 to 15 years," Korosis said.

HarbourVest Partners LLC has been very active in GP-led restructurings in 2019. "It certainly kind of picked up speed in the past year. It used to be something where it was maybe was a reflection of a more difficult set of assets that required more time," the firm's managing director Carolina Espinal said. It allows GPs to take quality assets that may need more time to fully create value, and provides liquidity and strong returns for investors, a win-win across the investor base, she said.

Co-investment continued to grow

Co-investments remained abundant in 2019. LP demand for these opportunities rose to an all-time high in the Rede Liquidity Index for the second half of 2019, with 93% of 153 LP respondents saying they expect to maintain or increase allocations to the strategy in the coming months. "[Co-investment is] going deeper into the buy-side ecosystem from the fund of funds that championed it to end investors like pension funds, insurance companies, endowments," Rede's Church said.

Co-investment reduces the cost entry point to deals and private equity exposure, Espinal said, but the market has brought in specific capabilities in terms of co-underwriting, and working alongside a GP to unlock deals that are outside their investment remit.

But it is fair to say that a lot of GPs still struggle with the level of demand from LPs, and that not all LPs have adequate resources for the strategy or are in a position to execute quickly enough, Espinal said. "There's probably still a gap between the demand and desire for co-investment as opposed to the ability to execute on that," she added.

Opinion elsewhere is that demand is fueled by top-of-the-market conditions. GPs are deploying outside their traditional remits in an already competitive market, and LPs are spending money to build up teams in order to avoid higher fees. "It's here to stay, and it's a semi-permanent feature of the market. But then I think, would it be easier to just reprice the industry and have everybody investing the right-sized fund [with fees of] 1.5 and 10 [as opposed to the traditional two and 20 fee model]?" an adviser said, speaking on the condition of anonymity.

European growth capital surged

The U.S. growth market matured long ago, but European growth businesses are now having their moment in the sun.

Growth capital available to European businesses has grown fourfold in the past four years. Between 2017 and 2019, $36 billion was raised for funds that focus entirely on technology or whose investment strategy is clearly based on growth, excluding venture capital. This compares with $9 billion raised between 2013 and 2016, according to HarbourVest and Preqin data. "[There] has been a fundamental gap relative to the U.S. of managers focused on growth investing," Espinal said, but U.S. growth players are now moving into Europe and some managers are also raising dedicated growth funds.

Hermes GPE's Korosis, who leads the firm's growth investing strategy, said Europe's growth capital space is a phenomenal opportunity because it is where he sees the largest gap in funding. Across the past decade, Europe's venture market has developed, building companies that are ready for the next stage of growth. "[These companies] are closer to our DNA as investors," Korosis said. "They are real companies with real business models that you can analyze — it is not a game of backing a team and an idea, which is the venture space."

The ability to streamline business models and disrupt larger competitors through the use of technology and software is also attractive to private equity firms.