Raising capital in a liquidity crunch
Not long ago, private markets funds were raising a new fund every 18 to 24 months. Today it can take that long to reach target commitments. So how are LPs and GPs viewing this turnaround and what does it mean for the industry?
“It’s the toughest time for fundraising in two decades,” says Weichou Su, Partner & Head of Asia at StepStone Group.
“It’s one of the most difficult fundraising environments I’ve seen,” adds Rebekah Woo, CEO and CIO of Singapore-based single family office, Pioneer Generation & Serene Group of Companies.
And Greg Durst, Managing Director of ILPA, goes perhaps further, when he says: “It is arguably the most difficult fundraising climate at least since the GFC and if not, in the history of private markets.”
To put the challenges into perspective, Durst explains: “There is a significant imbalance between the capital that GPs would like to raise and the amount LPs have available.” Preqin research suggests that there are nearly 14,000 private markets GPs looking to raise a total of $3.3 trillion; yet fundraising for 2023 is likely to come in at around $1 trillion, according to Bain & Co.
The stark contrast between what managers are looking for and what LPs can invest is the result of a confluence of the denominator effect – in particular as private markets marks have been slow to move valuations downwards – a lack of exit opportunities so capital is not flowing back to LPs, public markets disruption, geopolitical tensions, and uncertainty around the macro-economic picture in some key markets.
Alternatives to alternatives
There is, of course, another factor weighing on institutional minds when making allocation decisions: the high interest rate environment in many markets, which can have an effect on the relative attractiveness of private markets. “One of the biggest challenges for investing in the current market is that we are able to get more than 6% for USD cash,” says Woo. “Any investments will have to give significantly higher risk-adjusted returns. While we continue to review investment opportunities, we are extremely selective.”
It's clear that the days of raising a fund every two years are behind us. And while that may not be a welcome development for many GPs, it is providing LPs with some breathing space to select the right funds to back. “LPs are currently looking to reduce the number of GPs they work with and they are reducing their commitment sizes,” says Durst. “Yet they are also skipping vintages without fear of retribution.
GPs used to say they wouldn’t call an LP again if it skipped a vintage; today, they are responding with: can I call you in 2024? Today’s environment calls for a little more grace on the part of GPs in their conversations with LPs.”
That grace will be particularly needed with pension funds. “When we speak to pension fund LPs, we are hearing that many are cutting back their allocations,” says Su.
LPs are currently looking to reduce the number of GPs they work with and they are reducing their commitment sizes
Not all LPs are in this position, of course. “Our deployment and commitment targets are the same as they have been in previous years,” says Liam Coppinger, Head of Private Equity Asia at Manulife Investment Management. “I suspect that will be the same in future. The denominator effect is less of an issue for us over the long run because of our overall asset allocation mix.”
“We haven’t scaled back our deployment this year,” says Sarah Farrell, Managing Principal in the Private Equity Group at Allstate Investments. “Although we are seeing lower distributions so it’s unclear what our targets will be next year.”
However, the less frenzied fundraising environment is creating opportunities, she adds. “This is one of the most exciting environments I’ve been in,” she says. “The denominator effect has taken the heat out of pricing and, while the deal flow in co-investments is down, the quality of what we are seeing is much higher and only the right partners are winning assets.”
And, perhaps counter-intuitively, this is bringing some investors out from the sidelines. “This is a great time to be gearing toward investing – in the right opportunities,” says Ariel Shtarkman, Managing Partner, Undivided Ventures and Principal of single family office Orca Capital. “As a family office, we were often disadvantaged two years ago.
By the time deals came to us, they probably weren’t the right ones and they were overpriced. Today, we see many more interesting opportunities, and it is a question of evaluating the most promising sectors.”
Opportunities for those with capital
The same appears to be true for fund investing. “This could be a great time for LPs to gain access to funds they may have missed out on in the past because they were over-subscribed,” says Dorothy Kelso, Global Head at SuperReturn. “With many firms’ existing investors having to skip vintages or lower their commitment size, LPs with capital will find themselves at an advantage.”
LPs are also seeing other benefits. “Funds are now coming back to market at a more moderate pace,” says Abe Finkelstein, General Partner at Vintage Investment Partners. “A combination of this and the slower deployment pace by GPs means we now see much more vintage year diversification compared with previously – that’s a big positive of investing at this point.”
Overall, the main effect of the liquidity crunch we currently see among LPs is for much slower fundraising processes. There may also be some GPs that don’t manage to raise capital at all. Yet Finkelstein also points to another trend – one he welcomes. “There is no shame in a firm coming back with a lower fund size this time,” he says. “In fact, I give credit for that as long as the fund size is appropriate for the strategy. In 90% of cases, GPs probably need less capital today than in the past few years. We’ve had funds coming back to us with smaller fund sizes and we’ve actually increased our commitment to them.”
