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Past performance does not necessarily augur future marriage

Past performance of priavte equity funds is a weak indicator of whether an existing client will reinvest with a fund, a new survey has revealed.

The survey of 434 funds by alternative assets research firm Preqin found that while GPs usually raised more money faster, the difference between the top and bottom performers was not that pronounced.

In further research that also used Preqin’s database of 5300 funds, it was shown that past performance was a weak indicator of whether an existing client would reinvest with a fund.

There was virtually no difference between the top and bottom quartile performers when it came to persuading existing clients to reinvest. While the top quartile achieved an average 66 per cent of returning investors in recent funds GPs raised, the bottom quartile had an average 67 per cent of returning investors.

“While past performance is a key factor, there is no single attribute that limited partners (LPs) look for in a potential investment – particularly when they already have an existing relationship with a manager,” Preqin content producer Alex Jones said.

“For example, an LP has to weigh up the terms offered by a fund, its strategy, the strengths of the GP’s team, regulatory/legal concerns and even the brand and reputation of the fund manager. Institutional investors represent a broad and diverse group and consequently their requirements, resources available and aims can vary to a large degree.”

Researchers also found that more than half of the investors interviewed were unhappy with current degree of alignment of interests between GPs and LPs.

“The more prominent issues that we are seeing at present for LPs at an industry level are transparency and a desire to have increased alignment of interests between fund managers and investors,” Jones said.

“Following the economic downturn, many institutional investors are reacting to market conditions by seeking more disclosure from their fund managers, in an effort to help reduce their risk exposure. In addition, the more competitive fundraising conditions that have resulted from the financial crisis have tipped the balance of negotiating power towards investors, enabling them to push for more concessions in terms of management fees and other fund terms.”

Jones said that LPs were concerned about alignment of interests from two perspectives: downside and upside protection.

Downside protection primarily involved investors looking for GPs to commit significant levels of capital to their own funds.

On upside protection, investors were looking at GPs‘ annual management fees to ensure they were not too high, that they penalised investors, or were too low – thus impacting performance of the fund.

Investors also wanted to ensure carried interest was not distributed too early so as to risk over-distribution and that any clawbacks that were necessary should be enacted early and promptly, Jones said.

Despite there being more competition for fundraising, the researchers did not find a pronounced difference in the top and bottom quartiles in terms of their capacity to raise a bigger new fund.

Of top performing funds, 72 per cent were able to achieve a successor fund that was 25 per cent larger. In the fourth quartile 66 per cent of funds raised a fund that was 25 per cent bigger than their previous effort.

“It appears that while top performing funds are more likely to raise bigger a fund, managers that have not performed as well relative to peers have also proved successful in raising bigger vehicles,” the report said.

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