LPs Cautious As Fund Raisers Come Calling

Investors are likely to greet buyout firms coolly in 2011, when fund managers are expected to hit the road in their biggest effort at fundraising since the boom years of mid-decade.

Pension funds, endowments and other institutional investors, while hungry for returns, also have keen memories of the financial crisis that followed the boom, threatening the very existence of their organizations, so their appetite for illiquid, long-term holdings like buyout funds may not return until the current generation of fund custodians retires.

At least in the near term, limited partners are also likely to focus on smaller funds that may offer greater potential for outsize rewards.

These observations and others emerged from the Buyouts Texas conference last month in Dallas, sponsored by Thomson Reuters.

“Right now people are allergic to private equity, broadly speaking,” said Chris Douvos, the co-head of the private equity division of the Investment Fund for Foundations in Palo Alto, Calif., which serves endowed charities, foundations, endowments and other non-profit organizations. He predicted that investors, chastened by the near-meltdown of 2008 and 2009, would not warm to the asset class before 2013 or 2014.

Dealmakers, however, are expected to be out in force in 2011 to raise new funds. In Connecticut alone, 46 percent of the buyout shops, venture capitalists and other private equity firms that responded to the semi-annual ACG-Thomson Reuters DealMakers Survey, sponsored by the Association for Corporate Growth and the publisher of Buyouts, said they plan to start raising a new fund in 2011, and no one said it would be smaller than their last fund.

But bigger may not look better to the organizations that are being asked to invest, said Tripp Brower, a founding partner of Capstone Partners LP, a Dallas placement agent. LPs have begun to warm to new pitches from buyout firms, he said, but the smaller fund is more in vogue. “There is a very heavy reach for that elusive 3x multiple cash on cash in that smaller fund range,” Brower said. “You can find some real value at the lower end of the market, in smaller funds.”

Douvos said that private equity weakens its argument by maintaining its long-term, illiquid and uneven returns outside the metrics of modern portfolio management that LPs use for their more conventional investments. He urged GPs to reintroduce risk-adjusted returns into the discussion.

“We as an industry don’t have a good language for risk,” Douvos said. “3x means nothing out of context. You have to contextualize it in terms of public markets, you have to contextualize it vis a vis risk.”

Another focus for LPs today is the direct co-investment, which enables them to reap the returns that successful buyout deals can yield without the 2-and-20 percent share that they typically agree to pay a GP, said Maurice Gordon, a senior investment manager at the Guardian Life Insurance Company of America.

More LPs are going the direct investment route, Gordon said, and while buyout firms may resist it, they could benefit. “Co-investing is all about relationships,” he said. “In the long run, it will make you a lot of money if you handle it correctly.”