The January discussion paper by two professors, “There is Something Special about Large Investors: Evidence from a Survey of Private Equity Limited Partners,” adopts as its premise the findings of recent research showing that the private equity portfolios of large investors outperform those of smaller investors. To answer why, the authors—Marco DaRin, associate professor in the department of finance of Tilburg University, and Ludovic Phalippou, associate professor of finance at the Said Business School at the University of Oxford—conducted a survey of 272 investors based in 30 different countries.
The authors studied three measures of investor activity: screening, contracting (negotiating terms) and monitoring. Overall, the investors studied spend 26 days on average evaluating a commitment to a sponsor they haven’t worked with before, and 16 days on average evaluating a re-up. They spend 11 days on average benchmarking partnership terms. As for monitoring, investors studied put a representative on the fund advisory board an average of one out of every three funds they back. More than half (57 percent) of investors studied have co-invested alongside at least one of their sponsors.
On all three fronts, the survey found that investors that managed bigger private equity portfolios did more than those managing smaller ones. They “spend more time screening funds, are more likely to receive side letters, to visit portfolio companies, to interview, to visit portfolio company executives, to use their own models to evaluate funds reported Net Asset Values, to co-invest with funds and hence pay lower fees; they are also more often on their funds’ advisory boards, and have better attendance,” the authors wrote. The survey did not find a similar correlation between time spent on these activities and other investor characteristics, such as experience in the asset class, type of organization (endowment, pension, etc.), or the experience and networks of the investment officers.
Other differences also surfaced from the survey. Compared with their peers, investors with the largest private equity portfolios tend to put more emphasis on evaluating investment strategy, diversification benefits, employee turnover and the contacts of the fund managers they’re evaluating, according to the report. Investors with smaller portfolios, the authors wrote, “pay significantly more attention” to the educational backgrounds of the fund managers, the potential for generating business for a parent organization, the opinion of an adviser, and the anticipated impact of committing to a fund on access to future funds managed by the same sponsor.
Understanding the behavior of big investors has become more important in light of the recent rise of mega-limited partners. According to the report, nine pension funds and 11 sovereign wealth funds around the world manage more than $100 billion in assets. That is up from none 20 years ago.
Other findings of the survey:
- Private equity investment teams are not generously staffed, with an average of 15 funds and $250 million in assets per professional.
- Half of the investors studied provide a performance-based bonus to staff.
- Employees at investors with the biggest private equity portfolios tended to oversee fewer funds, to focus just on private equity rather than cover other asset classes as well, and to be more likely to be eligible for performance-based bonuses.