Need To Know

As evidenced by the desultory fundraising numbers for buyout shops so far this year, many limited partners have slowed their pledge pace or else stopped completely. The denominator effect provides a ready explanation for taking this stance, but LPs should be careful to weigh current allocation issues against the potential hazards of settling into a holding pattern with regard to private equity investing.

First, there’s evidence that the denominator effect is getting a bit long in the tooth. The twin impact of the recent modest rebound in the public markets – both the Dow Jones Industrial Average and S&P 500 have gained ground for three consecutive months now – and the writedowns of fund holdings trickling out of buyout shops due to fair value accounting requirements is bound to start pushing asset allocation percentages back toward acceptable ranges.

LPs should also think twice about missing out on the performance of vintage 2009 funds. Going by the old ‘buy low, sell high’ adage, the feeling is that, despite the lack of available leverage, deals made now have great potential to outperform.

The latest white paper from Landmark Partners, entitled ‘The Denominator Dilemma,’ addresses the risks for LPs who pull back from the private equity asset class. The Simsbury, Conn.-based firm, primarily a secondary investor in private equity and real estate funds, believes putting the brakes on in the near term in an effort to reconcile allocation levels could be a mistake in the long term.

Among Landmark’s main points is the need for LPs to keep some semblance of a pledge pace intact in order to continue to develop talented staff and keep relationships with strong GPs.

“When no commitments are made to a private equity program, or it is radically reduced in scope, it is difficult to maintain proprietary skills,” the firm states, adding later: “Similarly, many of the best private equity managers allocate fund capacity to investors who have continued to make commitments even when times are tough.”

One option for LPs on the fence is to make commitments to secondary funds “as their generally shorter times to distribution give added flexibility in planning,” Landmark notes.

LPs are buying into that logic as marketing efforts by secondary firms have fared pretty well of late. Recent examples of success include Goldman Sachs, which closed its GS Vintage Fund V with $5.5 billion in commitments in mid-April, and Harbourvest Partners, which secured pledges totaling $2.9 billion for its seventh secondaries fund, Dover VII.

Landmark itself is out in the market with Landmark Equity Partners XIV. According to the latest Thomson Reuters data, the firm is targeting $2 billion for the pool, and it’s three-quarters of the way there, with total commitments to date at $1.5 billion.