Newly empowered LPs are exercising caution

Some investors have started to push back on GPs, but it appears they are hesitant to slam on the brakes for fear of missing out on strong returns down the road.

Investors are in a delicate position. As the challenging fundraising environment drags on, they have found themselves with a little more leverage than they’ve had in a long time. But they need to be careful to not make hasty decisions that could haunt them down the road.

As affiliate VCJ reported last week, two recent occurrences indicate that LPs are more willing to say no to GPs. First, OpenView Venture Partners, a well-regarded firm, missed the $800 million target for its seventh fund, coming up $230 million short. At least two LPs from prior funds wrote smaller checks for Fund VII than they did for Fund VI: the Florida Retirement System Trust Fund and the Texas County and District Retirement System.

Second, an LP balked at what is normally a routine GP request for a fund extension. The Marin County Employees’ Retirement Association voted against a recommendation to approve a two-year extension for Abbott Capital Private Equity Fund VI, a $1.02 billion fund of funds launched in 2008, we reported. (Other LPs this week outvoted Marin County to grant Abbott’s extension request, we reported in a follow-up report.) We interpreted Marin County’s move to mean that it was more eager to get a distribution – even at a discount – from Abbott by liquidating the remainder of the fund, which apparently still has about 400 unrealized portfolio companies.

Following that news, we were surprised to learn this week that the Fresno County Employees’ Retirement Association didn’t follow through on a plan to pause new commitments to private equity in the second half of the year. It is an active investor in buyout funds, with recent stakes in vehicles from CVC Capital Partners, Cinven and Oak Hill Capital, among others. On the venture front, the pension mainly focuses on funds where it can write large checks, like the $9.4 billion Insight Venture Partners XI and the $4 billion TCV XI, committing $10 million to each.

Like many other LPs, Fresno County has been taking a close look at upcoming distributions, with the slowed exit market causing liquidity concerns. Investment staff and the pension’s consultants widely differed on projected distributions. The consultants projected a combined $580 million in PE distributions for 2023 and 2024, but Fresno County investment officer Anirudh Chowdhry said the system’s internal analysis projected distributions totaling just $300 million for the same period.

Worried the pension would come up short, Chowdhry told the board, “I am recommending a pause in new commitments for the remainder of the year because distributions are uncertain, which could cause a substantial negative cashflow making FCERA a forced seller of liquid assets at an inopportune time.”

So, it was a surprise when the Fresno County board pulled the staff’s recommendation to pause new commitments from their meeting on April 5. Board president Rauden Coburn said staff would “refine” its proposal due to undisclosed issues he and other board members had with a report that supported the recommendation.

Our take is that the board is hesitant to bet against PE because because of FOMO. Private equity generated a TVPI multiple of 1.7x and an IRR of 14.29 percent since inception for the pension system as of March 31, according to a recent report.

Kelly DePonte, managing director of placement advisory service Probitas Partners, which has helped more than 120 private fund managers raise $102 billion in capital, says he sees LPs “being more cautious about making hasty short-term decisions in what is a long-term asset class.”

Imagine you’re Fresno County five years from now and you’re looking at your performance. Are you more or less likely to regret pausing commitments in the second half of this year? If you’re really committed to PE for the long haul, does it make sense to pause commitments even for six months?

Says DePonte, “LPs realize that difficult markets like the current one can reduce pricing pressure on new commitments, helping to drive future returns and have been reluctant to dramatically decrease new commitments. Many of them have been trying to be flexible on portfolio allocations or have been looking to secondary sales to increase room for new commitments – though that sector is having its difficulties as well. But a continued dearth of distributions continues to put pressure on them.”