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LPs Look To Asia, Infrastructure, Small Funds In 2008

Where are limited partners looking to put their money in 2008? Asia, infrastructure and smaller buyout funds, say investment advisors who dusted off their crystal balls to tell Buyouts what to expect from LPs this year.

“Across the industry, clearly Asia has been an area of greater interest, in terms of the amount of product available and the number of people thinking about it,” said Erik Hirsch, chief investment officer at Hamilton Lane, the asset management firm. “I think what’s always a good indication is the number of times you hear it mentioned at conferences,” and Asia comes up all the time, Hirsch said.

Bill Walsh, a managing director at Portfolio Advisors, another advisory firm, echoed those comments, even going as far as to say the world’s most populous continent may be a bit too crowded with private equity pros. “If anything, I think Asia’s probably a little overheated,” he said. Of course, he acknowledged, that won’t stop his firm or its clients from investing there. Private equity buying in the Asia-Pacific region reached almost $70 billion in 2007, and the number of firms raising Asia-focused shows no signs of slowing down.

LP appetite is also growing for infrastructure investments that provide reliable, consistent cash streams regardless of how the public markets are performing. While the hold time on these investments is longer than for a typical portfolio company, and average returns are in the low double digits—10 percent to 12 percent compared with private equity returns that are often north of 18 percent—they offer reliable cash flows that hedge against volatility. “It’s gaining momentum,” Walsh said of infrastructure investing. “There’s definitely more interest in infrastructure, particularly asset-backed infrastructure [such as hospitals and power plants] as opposed to roads. It’s a recurring fee stream.” Some public pension funds have already carved out new allocations to meet this need.

In November, the California Public Employees’ Retirement System created the “inflation-linked asset class,” which combined its existing infrastructure and real estate investments valued at $573 million under the new name. In total, CalPERS decided to set aside $2.5 billion for the asset class, which also includes timber, commodities and related inflation-hedging investments. Also in November, the Washington State Investment Board allocated five percent to its own new asset class, called “tangible assets,” devoted to infrastructure investments. The funding came from a reduction in its fixed income allocation. At the same time, WSIB bumped up its private equity target allocation from 17 percent to 25 percent, and hiked its allocation to real estate from 12 percent to 13 percent, both of which are the result of a scaled back allocation to public equities. TIAA-CREF also plans to direct more capital to infrastructure investments in 2008.

This year may also see the investment pendulum swing away from mega-funds and toward small to middle-market vehicles and venture capital funds. “We go through this every few years. The mega-fund backlash. I’m hearing a lot of, ‘I don’t like the big stuff. So let me do something that’s not that,’” said one adviser, who did not want to be named sharing the thoughts of LP clients. That sentiment was a common refrain among many limited partners, from TIAA-CREF to the Doris Duke Charitable Foundation, who decided to hold back from the large buyout funds in favor of small and middle-market players.

Overall, LPs are expected to boost or at least maintain their allocations to private equity this year, according to a 2007 survey of 45 private equity investors conducted by Coller Capital, a private equity firm. And individual commitments have also been on the upswing. Public pension funds such as San Francisco Employees’ Retirement System that until recently deployed capital in $20 million slugs are now making $30 million and $40 million outlays. Despite more capital flowing to the asset class, one advisor warned LPs to take a cautious eye toward general partners who may try to create a false sense of momentum about their own funds in 2008. “We’ve seen a slowing distribution market and so you basically have, from an LP perspective, GPs who have spent money quickly. They haven’t returned much capital and now they’re back looking to get their coffers filled again,” the adviser said.—J.P.