LPs expect to reduce commitments to new funds due to worries about a drop in distributions next year, according to a report from placement agent Rede Partners.
Exit activity has cooled with the slowdown of IPOs, as well as regular M&A, putting liquidity pressure on LPs who rely on money flowing back in to make new commitments. Several retirement systems recently slowed private equity pacing plans for 2023, attributing the move to a need to rebalance overweight PE exposure.
According to a report outlining the results of the 2H 2022 Rede Liquidity Index, 35 percent of the 115 institutional LPs who participated in the survey expected to decrease commitments to new PE funds over the next year. Just six months ago, only 17 percent of respondents planned on reducing commitments.
Rede uses a weighting system to create its index number score, with anything under 50 showing that, on average, LPs expect to decrease commitments over the next 12 months.
The 2H 2022 Liquidity Index score was 41, the lowest figure in the survey’s five-year history and a drop from the 70 reported in the 2H 2021 report.
Nearly 85 percent of LPs expect a reduction in distributions over the next year, Rede Partners’ report said.
According to the report, the closed IPO and SPAC markets weigh heavily on the mind of LPs. Rede Partners also said it has seen evidence of GPs putting sale processes on hold due to either poor short-term trading or an attempt to better time the market.
When asked about their biggest concerns over the next year, 50 percent of respondents said the slow pace of exits and lower distributions weighed heavily, making it the top answer. Other top concerns were unrealized write-downs and the high volume of re-ups LPs consider.
“We find that distribution velocity is closely correlated with LP liquidity,” said Gabrielle Joseph, head of due diligence and client development at Rede Partners.
GPs may shift strategies when realizing the liquidity fears facing LPs, Joseph said.
“We believe GPs will wake up and focus on liquidity. But if almost every GP decides to not exit into a volatile market and decides to hold off to next year, suddenly we will see a huge slowdown in the industry and a gum-up in fundraising,” Joseph said.
While much has been made of the denominator effect’s impact on allocations, the survey suggests this problem may be overstated. Only 20 percent of respondents said managing overallocation to private markets was a key concern over the next year, and two-thirds of respondents said their private market portfolio sat within their allocation range.
However, 34 percent of North American LPs reported they were overallocated to private assets compared to only 10 percent of European LPs.
Only 20 percent of LPs also said managing down overallocations was a major concern for next year, according to the report.
LPs also favor existing relationships than placing commitments with new managers, although survey respondents remained tepid to both, according to the report.
“Against the current macro backdrop, investors are taking a more cautious approach, seeking to re-underwrite each relationship – and showing an increasing willingness to rotate out underperforming GPs within their portfolios,” the report said.
According to the report, roughly one third of LPs are planning to increase exposure to mid-market and lower-mid-market buyout funds, while venture capital and growth equity have fallen out of favor.
Also surprisingly, tech trailed healthcare and impact funds in sectors where LPs plan to deploy capital, according to the report.
Joseph said impact and sustainability ranks as perhaps the top priority for European LPs.
“It has not nearly been on the agenda in the US to the same degree. But we are now seeing signs that US LPs are on the same journey as their European peers, just near the beginning,” Joseph said.