LP Survey: Quality of Management Team Remains the Defining Factor in General Partner Selection
“We are happy to pay regular fees investing in managers with a proven track record,” says one limited partner.
15 March 2021
Investors appear to be split with how they view the number of fund manager or general partner (GP) relationships within their investment portfolios. Pandemic-driven volatility over the last 12 months has caused investors to carefully evaluate the GPs they allocate to within alternative asset classes. And even though 46 percent of those surveyed by SS&C Intralinks said they planned to increase the number of GP relationships, 42 percent said they would maintain the same number.
The 2021 SS&C Intralinks LP Survey also found that mid-market managers, running between USD 100million and USD 500 million in AUM, continue to be the preferred option for investors in 2021, with private equity (PE) as the most active area of manager selection.
Finding the Goldilocks zone
Gabriele Todesca is head of equity partnerships at the European Investment Fund, which seeks to support Europe's small and medium-sized businesses by designing innovative financial products, provided by a range of partners including banks, leasing and microfinance institutions, private equity and venture capital funds.
He confirms that within private equity, the EIF’s sweet spot continues to be between EUR 100 million and EUR 500 million across multiple funds. “We are quite active [in] seeking out first-time fund managers. That is one of the EIF’s unique traits, which brings the overall average AUM down. We are also quite active in more niche areas of private equity; specific segments, specific countries and specific strategies, which don’t lend themselves to having huge AUM,” explains Todesca.
What is also notable within the SS&C Intralinks LP Survey is the continued focus among LPs on managers running north of USD 1 billion in AUM, in addition to allocating to middle-market GPs. Nearly one-third of investors said that this would remain a key priority as they look to back high-quality managers.
This is understandable given the level of uncertainty that COVID-19 has generated within financial markets. Trusting GPs with proven track records and an established name in the industry has become a bigger issue for LPs who need to allocate to what they consider to be a safe pair of hands.
One hedge fund investor who invests in managers at both ends of the spectrum is Europe-based Prime Capital AG. On the one end, its flagship fund-of-funds, PCAM Blue Chip, invests in a diversified basket of best-in-class ‘blue chip’ hedge funds with at least EUR 5 billion in AUM and a five-year track record.
“Then at the other end of the barbell, we have PCAM Select, which targets managers with a minimum AUM of USD 500 million. Our third product, PCAM Liquid Alternative Credit, invests in niche capacity-constrained credit managers, which may have an AUM as low as USD 50 million,” comments Philipp Zehrer, investment manager, hedge funds, at Prime Capital.
With more than 20 years’ experience, the investment team at Prime Capital has developed an extensive network of relationships with the managers it looks at and invests with. This has proven to be especially important over the last 12 months when rebalancing the PCAM Blue Chip and PCAM Select portfolios, as it has negated the inability to meet management teams in person. In both the hedge fund and private equity space, leveraging existing relationships has been a defining factor in terms of ongoing GP selection.
“It’s not always easy finding the right investment opportunities,” concedes Zehrer, “but it is also far from impossible. It depends on the individual manager. Over one-fifth of our book has been investing with various managers continuously since 2007.
“We will most likely be adding one or two new managers to PCAM Select over the next two or three months.”
Many happy returns
Private equity investors continue to be broadly pleased with the returns they are getting, with Todesca noting that some of its Healthcare Services managers, and Healthcare Technology managers, have proven to be “very resilient investments over the last 12 months.”
“Several of our buyout funds have proven very resilient as well; overall the asset class hasn’t been very negatively impacted by the pandemic.
“Going forward, our main focus is going to be on sustainability of valuations and for this, we think strategies that are not too passive will be more interesting; for example, buy and build strategies compared to plain vanilla buyout strategies, which may be slightly more exposed to market cycles,” says Todesca.
Some investors remain confident that valuations, on average, will remain lower in some parts of the lower middle-market, and as one LP remarks: “In terms of manager selection, in the lower middle-market segment there is more room for picking interesting strategies and GPs than in the upper middle-market.”
This reinforces the earlier point made regarding LPs looking closely at managers in the USD 100 million to USD 500million AUM range.
According to a report by the British Private Equity & Venture Capital Association (BVCA), 82 percent of investors said they would consider investing in Fund I, when considering emerging managers. Moreover, nearly 90 percent said they could get comfortable investing with an emerging manager who they have known for less than two years.
Todesca says the EIF would be part of that 90 percent, given that the Fund actively backs emerging managers, including those it has known for less than two years.
“Sometimes these are spin-offs from other fund managers, and they might be people we’ve known for longer than two years. What is interesting about the last 12 months is we are now more comfortable with the idea of investing in an emerging manager we’ve never met in person. It’s been quite a change; it’s not something we would have ever considered in the past,” states Todesca.
He goes on to say that the quality of the management team is still the key criterion when reviewing managers at the pre-investment stage. “The team might include people who have never worked together before, people whose track records are combined with those of others, meaning you need to drill down deeper into what deals they’ve done. In the end, it all boils down to the quality of the team,” says Todesca.
Zehrer is in full agreement on this: “For our flagship fund, given the size of managers we invest with the quality of the management team is key. We do look at who they’ve hired, the quality of the investment models and risk models they use, etc.”
On the strategy side, Zehrer says the team is still a little underweight on divergent strategies such as CTAs and discretionary macro. “We’ve been searching for quite some time but are yet to find the right manager(s). We did recently add a quant manager to our flagship fund. We’ve known this particular manager a long time and we were able to invest with them and be a bit anti-cyclical with our manager performing positively, while the average quant fund had a lackluster performance in 2020.”
Global quant equity market neutral assets fell by USD 786 million in Q1 2020; the first Q1 outflows in that sector since 2009. Major names like Renaissance Technologies and Bridgewater Associates experienced an annus horribilis.
Reactive investors have provided opportunities for those like Prime Capital to step into the breach.
In the highly competitive private equity space, Todesca emphasizes that in 2021, the aim is to try and understand the drivers of value creation. “We try to deconstruct them into single factors, such as multiple arbitrage, profitability enhancements and others. We look for those key insights to determine the value creation of the team.”
One final observation on GP selection trends in 2021 is that it appears LPs are less concerned about fee negotiations, especially when it comes to emerging managers. The appeal for more attractive potential returns remains the primary driver.
But not everyone shares this view.
“The desire to access interesting talent is probably the most interesting one for us,” confirms Todesca. “Or unlocking new talent. Especially when it comes to spin-offs coming out of existing PE firms. It gives us the opportunity to reset the interest alignment, which can create a very positive dynamic in terms of GP/LP cooperation.
“On the other hand, EIF also has a strong policy objective to develop the European PE/VC market and nurture the ecosystem, and supporting new teams is a key ingredient in this. Those are the two key reasons for why we want to allocate to emerging managers.”
Zehrer concludes by adding, that in the hedge fund space, one pays lower fees to emerging managers for a reason.
“It’s a game of statistics — in terms of who becomes a successful, established manager — and you need a special toolset to invest with emerging managers. In contrast, large, established managers with strong track records typically do give no-fee discounts.”
As Director of Strategy and Product Marketing for Intralinks, Meghan McAlpine is responsible for the go-to-market strategy and driving the growth of the company’s Alternative Investments solution, the leading communication platform for private equity and hedge fund managers and investors.
Prior to joining Intralinks, Meghan worked in the Private Fund Group at Credit Suisse. While at Credit Suisse, she raised capital from institutional and high net worth investors for domestic and international private equity firms.