Back to School: LPs’ key focus is GPs’ skin in the game: survey

More than anything, limited partners want their GPs to kick in meaningful amounts of their own capital into their funds.

On the other hand, investors don’t seem concerned about inclusion of ESG principals or strict adherence to the Institutional Limited Partners Association principles.

That’s according to the 2016 annual investor survey from Probitas Partners. Probitas received 86 responses from executives at institutions for its 2016 survey, conducted in late September into early October.

In the placement agency’s poll, 64 percent of respondents listed level of GP commitment as the most important term. (The respondents were asked to choose no more than four terms.)

“It is the key factor from investors’ perspective that best establishes alignment of interest between investors and fund managers,” the survey said.

The average level of North American GP commitment has historically hovered around 2 percent, though some firms tout the strength of their commitment by kicking in amounts well above 2 percent. Preqin measured the average GP commitment last year, including global buyout funds, at around 5.9 percent.

LPs traditionally want the GP commitment to be straight cash from the manager’s pocket rather than a management-fee waiver. Instead of paying out of pocket, the GP waives a proportionate amount of the management fee for LPs in exchange for a priority profit allocation once the fund starts to earn income.

Because the waiver is converted to a slice of carried interest, the GP commitment gets taxed at the capital gains rate of 20 percent, rather than regular income, which is taxed as high as 40 percent. The Internal Revenue Service has been looking into waivers as a potential tax dodge by GPs, though no rules prohibiting the practice have been promulgated.

On the other hand, only 14 percent of respondents focused on each of inclusion of strong environmental, social and governance policy, and strict adherence to the ILPA principles, the survey said.

Attractive strategies

Other terms LP focus on include distribution of carried interest among senior investment professionals (53 percent); management fee (46 percent); cap on fund size (45 percent); key-man provisions (44 percent) and carry distribution waterfall (44 percent).

In North American PE the middle market is king, and the most attractive funds to LPs in the middle market are those focused on operators, the survey said.

About 81 percent of respondents to Probitas’s 2016 investor survey listed the most attractive funds (given nine options) as those focused on operational improvements heavily staffed with professionals with operating backgrounds; 73 percent chose funds that pursue buy-and-build strategies; 51 percent liked funds focused on single industries; 41 percent supported funds focused on growth companies, often without taking majority control; and 40 percent liked restructuring/turnaround funds.

Within industry-specific funds, the most popular sectors (respondents were asked to choose no more than three) were healthcare (49 percent), technology (43 percent), retail/consumer (22 percent), financial services (16 percent), energy (15 percent), media/telecom (11 percent) and agribusiness (5 percent).

Amid pricing turmoil, energy fell from third place in last year’s survey.

Action Item: The full Probitas survey is here: http://bit.ly/2haJZaa

The San Francisco skyline and the Golden Gate Bridge south tower are seen from the Marin Headlands as they rise above the fog in Sausalito, California, on March 21, 2012. Photo courtesy Reuters/Robert Galbraith