The Global Financial Crisis created a perfect storm for private capital fundraising:
Far less capital was being called up while distributions slowed to a crawl
The decline in value of public equities left major LPs over-allocated to private equity
General market conditions created enormous uncertainty
LPs were left questioning their over-commitment strategies, with some even turning to the secondaries market to rebalance portfolios. The rate of new commitments plummeted; this was not a good time to be raising a new fund.
It is still too early to say what the effects of the Coronavirus will be, but we do know that a slowdown in the capital cycle can spell bad news for managers in fundraising mode, and this can be compounded by a drop in the value of public equities. However, fundamental changes in strategy and technology may give us cause for cautious optimism compared to the events of ten years ago.
Confidence in the Asset Class During Times of Crisis
The dot-com crash was still somewhat fresh in LPs’ minds when the GFC hit. However, while funds of this earlier era struggled to recover, many vehicles raised before and after the GFC showed far more resilience and performed well (with some notable exceptions). The ability of private fund managers to time their investments and manage portfolios effectively during a time of crisis was a key factor, something LPs today can take a degree of comfort from. Private capital allocation levels seem unlikely to drop, although the pressure to commit to new funds may well be reduced.
Data and Technology
Uncertainty in the wider market is likely, but LPs’ ability to understand their own portfolios is light years ahead of where we were a decade ago. Cash-flow modeling functionality, what-if analysis, the availability and integrability of market data… today’s sophisticated LP has a far greater degree of confidence in their ability to make decisions and understand how potential scenarios are likely to affect them as they track developments in real time. Multi asset class portfolio monitoring tools may prove to be especially advantageous in increasing investor confidence around decision-making during times of market uncertainty.
Investment Strategy
Co-investment and direct strategies are far more prevalent in today’s market, offering investors the ability to better control their exposure to private capital asset classes. This may prove to be helpful in lessening the impact of any denominator effect, although such a scenario would of course still impact GPs relying on co-investors to complete deals.
Coping with a Crisis: Advice for LPs and GPs
Advances in technology have allowed LPs to gain a far greater insight on both their private capital and wider investment portfolios. Such functionality is not limited to the most sophisticated LPs with deep pockets as many of today’s solutions are targeted towards family offices and smaller allocators. LPs relying on Excel-driven processes should see this as an opportunity to examine the additional insight which a modern data and analytics platform provides.
When it comes to making new investments, anticipation of a potential downturn has already led to a growing preference for established GPs in recent years. Current events are likely to further extend this trend, but sophisticated LPs have more tools at their disposal to digitize the due diligence process and identify resilient managers which may otherwise fly under the radar.
That said, GPs cannot fight this trend and must consider how to best attract LPs with concerns over uncertain market conditions. Establishing a strong brand during the marketing process is important, as is ensuring that every aspect of the firm exudes professionalism. The same due diligence tools harnessed by LPs can be adopted by GPs to proactively allow prospects to examine and analyze their track record in ways that a slide deck and PPM alone cannot accomplish. Smaller GPs must ensure that their back and middle office functions are of the same quality and standard as their larger cousins. A small fund size is no longer an excuse for poor quality reporting and may well hinder fundraising efforts.
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