2022 LP Survey: Insights on Alternative Investments

SS&C Intralinks®­­

2022 LP Survey Insights on Alternative Investments

Produced in association with

Editor’s Note Meghan McAlpine Sr. Director, Strategy & Product Marketing, Alternative Investments

Welcome to the sixth annual SS&C Intralinks LP Survey produced in association with Private Equity Wire.

The intent of this report is to gauge how investors are thinking about their general partner (GP) relationships, in addition to highlighting emerging themes that might help inform how investment firms do business over the next 12 months. For example, what are limited

consultants (19 percent). At 45 percent, North America was

partners’ (LPs) views on the size of manager they plan

the largest geographic representation, with 35 percent of

to allocate to? What are their views on transparency

LPs based in EMEA and the remainder in Asia Pacific and

and reporting, and how does this factor in to

Latin America.

environmental, social and coprorate goernance (ESG)?

How do they view the technology capabilities of GPs? And what are their overall views on the performance of alternative assets, both at an industry-wide level, asset-class level and sector-specific level?

This year, 199 global investors were surveyed for their views on the performance of alternative investment funds over the last 12 months and what their allocation programs might look like for 2022.

As GPs think about growth and seek ways to stand out from the crowd in the fast-paced world of global alternative investments, any insights they can garner on the current LP mindset are likely to be advantageous. We hope this report can help provide a roadmap as managers look to evolve and improve the GP/LP relationship.

Our thanks to the LPs who kindly gave their time to complete this year’s survey. Without the support of the global institutional investor community, we could not have

Family offices accounted for the biggest LP category,

produced the findings presented in this report. Your insight

representing 32 percent of investors, followed by

is greatly appreciated.

fund-of-fund managers (21 percent) and investment

2

Executive Summary •

There is a consensus among LPs that their alternative investments met or exceeded their performance expectations in 2020.

•

As such, three-quarters of LPs plan to increase their allocations over the next 12 months, with private equity (PE) and venture capital (VC) at the top of their lists.

•

More than half of LPs (55 percent) plan to increase their number of GP relationships.

•

Over 80 percent of LPs feel it’s important that GPs embrace technology to improve the quality of portfolio reporting.

•

•

LP sentiment is also mixed concerning the leveraged buyout space, with the majority of LPs either somewhat optimistic on the one hand, or cautious on the other hand. Managers who focus on clearly communicating their operational value strategy will likely assuage LP concerns in today’s high-valuation marketplace.

•

Technology could still be further embraced to improve transparency. LPs appear to be happy with the progress GPs have made, but they would like to see improvement on due diligence and ESG data.

•

Sixty-nine percent of LPs agree or strongly agree that market-dislocation opportunities, in the wake of the pandemic, should prove beneficial to alternative assets over the next 12 months.

LP interest in PE secondaries is somewhat mixed. Those who do plan to increase their exposure see opportunities for more LP-led deals over the second half of 2021.

Performance Sentiment Insights

GP Selection Intelligence

Transparency, Reporting and ESG

Page 4

Page 9

Page 15

Asset Allocation Trends

Macro and Sector Outlook

Conclusion

Page 20

Page 23

Page 25 3

Performance Sentiment Insights The last 18 months have proven to be a defining moment for most alternative assets, with private equity and hedge funds, in particular, generating resilient performance in the wake of the COVID-19 pandemic. It has been a period for active managers to demonstrate their true worth to institutional investors.

Hedge funds certainly had a standout year in 2020.

This is reflected in overwhelmingly positive sentiment among investors. When asked what their performance appraisal was for 2020, 80 percent of LPs confirmed that their alternative asset portfolios had either met or exceeded their performance expectations.

our expectations,” comments Yehuda Spindler, managing

On average, they returned 11.02 percent according to eVestment, the highest level since 2009 when the average return was 19.44 percent.

“Last year was an extraordinary year and one that exceeded director and head of research at Optima Asset Management, one of the industry’s oldest fund-of-hedge-fund managers.

Survey Methodology Types of investors surveyed `Family Wealth Office Fund of Funds Consultant/Advisor Pension Insurance Endowment/Foundation Sovereign Bank Local Government Authority

Surveyed investors by geography

35%

Europe, the Middle East and Africa

15%

Asia Pacific

5%

Latin America

45%

North America

4

“I think the outlook remains quite strong. It doesn’t look like the trends that hedge funds benefited from last year are going away anytime soon, which gives us a lot of confidence “On the family office and wealth manager side, they’ve been expanding their allocation to hedge funds and in the case of the latter, they’ve been building platforms to give their own end clients a better set of hedge fund managers to choose from. We see a number of wealth manager clients being proactive and expanding their hedge fund rosters. We are also seeing new users of hedge funds -- including pension plans -turning to them for the first time.”

and conviction that there will be positive momentum for alternatives in general.”

Hedge fund performance has continued to stay strong in 2021, gaining more than 10 percent through June; the industry’s strongest performance in 22 years. Now, managers are positioning for a dynamic performance environment heading into the second half of the year, shaped by ongoing COVID concerns.

Private equity and venture capital have also proven their worth over the last 12 months. So much so that 44 percent of LPs cited private equity as having delivered the best

‑ Toby Goodworth, bfinance

risk-adjusted returns, with 18.6 percent referencing venture capital. (See Figure 1.)

Figure 1: Within alternatives, which of the following asset classes generated the best risk-adjusted returns?

45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Private Equity

Venture Capital

Private Debt

Hedge Funds

Real Estate

Infrastructure

Commodities

5

Francois Massut is head of private equity funds at

Such has been the desire to seek out good quality buyout

Peugeot Invest, a French-listed investment company.

opportunities that for the first time in history, European

As a listed family office, it gives an investor like Peugeot

EBITDA multiples last year were higher than in the U.S. at

Invest the best of both worlds (i.e., the flexibility of a

12.6x compared to 11.4; the highest ever.

family office and the organizational structure of an institutional investor).

With Technology and Healthcare featuring prominently in deal activity, this perhaps also explains why this year’s survey

Its investment activities reflect and draw upon the

saw venture capital feature so strongly, given the amount of

industrial experience of the Peugeot family, and cover a

VC activity in those sectors. Year-on-year, the survey figures

range of diversified assets, mainly composed of direct

for VC increased from 11 percent to 18.6 percent and suggest

minority stakes, private equity vehicles, co-investments

that this is an increasingly important area of the alternatives

and Real Estate.

industry among LPs.

“We prefer to delegate to specialized sector-focused

“Despite the uncertain macro-economic environment due

GPs. Since we began building a program of investing in

to the global pandemic, our private equity portfolio has

growth tech buyout funds six years ago, we have seen

performed very well,” confirms Daniel Dupont, vice-chair,

the resilience and performance of these sector-focused

Europe at Northleaf Capital Partners (Northleaf), a global

funds — in particular during the pandemic last year,”

private markets investment firm with USD 17 billion in

Massut confirms.

capital commitments.

The median 10-year annualized IRR for global buyout

He continues: “Our investments grew 24 percent overall

funds last year was approximately 10 percent, according

in 2020, despite a negative return in Q1 due to COVID. This

to Bain & Company’s Global Private Equity 2021. More

was due, in part, to being relatively well-positioned heading

revealingly, the average gross pooled multiple on

into the pandemic. Our investment team works very closely

invested capital (MOIC) for 2020 was 2.3x; down on 2.6x

with our portfolio strategy and analytics team during due

recorded in 2019 pre-COVID-19, but higher than the 2.19x

diligence and throughout the life of our investments and we

average for the period of 2015 to 2019.

had minimal exposure to the industries most impacted by the 6

pandemic. In addition, our global investment strategy,

you should be well-positioned to invest in both parts of the

investing in primaries, secondaries (fund positions and

market; public and private.

GP-led transactions) and direct investments helps build an attractive risk/return profile for our investors. We expect to see this strong performance extend through 2021.”

One intruiging trend that could continue to accelerate is a convergence between the hedge fund world and the PE/VC world.

Indeed, there are many well-known hedge fund managers now running VC programs, including the likes of Tiger Global Management, Philippe Laffont’s Coatue Management and Two Sigma Ventures.

According to a new report from research firm CB

“Our goal will be to differentiate between which managers have competitive advantages on the public side, and those on the hybrid side; not everyone is capable of successfully making that leap.”

LPs set to increase their alternatives exposure Given the buoyant sentiment among LPs, it is perhaps unsurprising that the vast majority (approximately three quarters) confirmed that they would be increasing their overall allocation to alternatives over the coming 12 months.

(See Figure 2.)

Figure 2: Do you expect to increase your allocation to alternatives over the next 12 months?

Insights, Tiger increased its investments in Q2 2021 by eightfold from the same quarter a year earlier to 81, making it the top VC investor.

“Some hedge fund managers have been operating in the

28%

VC space for quite some time but we continue to see

72%

new entrants,” observes Spindler. “The trend is definitely moving in that direction. If you have the underwriting and analytical skill set, and data science capabilities, Yes

No

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One-third of LPs expect this to be a three to five percent

Private debt does not appear to feature that prominently

increase, although one in four LPs are more bullish on the

among those surveyed, despite the very obvious growth in

outlook and plan to increase their exposure by 10 percent

this asset class, especially in Europe.

or more. (See Figure 3.)

By the end of 2020, total assets under management (AUM) Figure 3: If you do expect to increase your allocation to alternatives over the next 12 months, then by how much?

had grown to USD 848 billion and are projected to increase 11.4 percent annually to USD 1.46 trillion at the end of 2025, according to Preqin.

40% 35%

This makes private debt the third largest among the private

30%

capital asset classes, behind private equity and Real Estate.

25% 20%

Despite this, only 10 percent of LPs said they would be

15%

increasing their allocation to private debt.

10% 5%

Thibault Sandret, director, private markets at bfinance, a

0% 1-3%

3-5%

5-9%

10% or more

leading global investment consultancy, comments on this finding by noting that private debt funds remained resilient

As was the case in last year’s survey, private equity remains the most overweight asset for institutional portfolios.

“We are going to increase our allocation to alternatives over the next 12 months. More specifically, we will invest in private equity growth tech buyout funds and we plan to increase our platform allocation in this area,” confirms Massut.

through the pandemic “which was the first large-scale test of performance for the asset class in a period of market stress.”

“This confidence boost, which follows the slow fundraising last year where many investors were in a wait-and-see mode, means commitments to the asset class are now picking up pace to maintain target allocations. The level of interest our institutional clients are currently showing for private debt is possibly at the highest level it has ever been,” states Sandret.

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GP Selection Intelligence Forty-three percent of LPs confirmed that they favored

At Peugeot Invest, Massut confirms that their focus is on

managers on the smaller end of the AUM spectrum last

specialists between USD 250 million and USD two billion.

year, overseeing assets between USD 100 million and USD 500 million.

“We invested a while ago with one manager with USD two billion in AUM who has since grown to USD six billion. Despite

One-third of investors backed managers with north

this, we decided to invest in their latest mid-market fund.

of USD one billion in AUM but only one in 10 LPs

We like this GP because they are very sector-focused on

backed managers with USD five billion+ in AUM, as

Healthcare and Education and are very close to the

Figure 4 illustrates.

U.S. government.”

Figure 4: What fund manager AUM size did you strongly favor in 2020?

This theme of backing smaller managers with up to USD 500 million in AUM on the one hand, with a cohort of managers running up to USD five billion in AUM on the other hand, is

50%

clearly in evidence for the year ahead, as Figure 5 illustrates.

40% 30%

Figure 5: What fund manager AUM size will you be favoring in 2021/2022?

20% 10% 0%

50% Less than USD 100 USD 100 USD 500 million in AUM million in AUM

More than USD 1 billion in AUM

More than USD 5 billion in AUM

40% 30% 20%

Why large-cap managers were less prominent is hard to surmise, but it perhaps points to the need for portfolio diversification as investors seek to compliment bulgebracket names with smaller, sector-focused specialists.

10% 0% Less than USD 100 USD 100 USD 500 million in AUM million in AUM

More than USD 1 billion in AUM

More than USD 5 billion in AUM

9

One should note, however, that with so much dispersion of returns among alternative fund managers, getting a clear understanding of the return drivers will be paramount for LPs and, in this continued virtual workplace environment, require them to conduct careful due diligence.

Let’s connect To underscore the point about diversification, this year’s survey reveals that over the next 12 months, more than half of LPs (55 percent) plan on increasing their number of GP relationships. Moreover, only eight percent said they would reduce the overall number, further suggesting that confidence with their GPs remains high on the back of last year’s performance. (See Figure 6.)

“We would much prefer to be with a ‘class A’ manager that runs a larger AUM base than with a ‘class B’ manager that runs a smaller AUM base. I will say, however, that part of the challenge of strong performance is [that] asset levels grow organically. Some managers who started with USD 500 million, for example, have seen their AUM grow to several billion dollars over the last year.

Against that backdrop, we want to continue to source new managers we think can enhance our portfolios. We want concentration with appropriate differentiation, but we certainly don’t want to over-diversify.” ‑ Yehuda Spindler, Optima Asset Management

Figure 6: Are you planning to increase, decrease or maintain the number of GP relationships you have over the next 12 months?

60% 50% 40% 30% 20% 10% 0% Increase

Maintain

Decrease

When asked about how they think about their GP relationships with private equity, a London-based leading private markets investor with over USD 60 billion in AUM states: “We are always seeking to blend re-ups with existing managers with a strong track record and with whom we have an established relationship, with new and emerging managers; especially where there are spin-outs of

10

high-performing teams from established managers. We

The quality of the portfolio management team remains

expect this activity to increase post-COVID.

the single most important criterion when selecting

“Overall, we would expect to have expanded our line-up of primary GPs over the next 12 months, in common with prior years.”

new managers, as investors build out their investment programs. Six out of 10 LPs cited this, while five out of 10 LPs selected historical performance as the second most important criterion. (See Figure 7.)

Figure 7: How would you rank the following when selecting a manager, with 5 being most important and 1 being least important: 5 4.5

Level of importance

4 3.5 3 2.5 2 1.5 1 0.5 0 Caliber of portfolio management team

Historical performance (i.e. prior returns through different economic cycles)

Fee structure

Quality of fund reporting

Quality of IT infrastructure

Every investor will have specific selection criteria for

Northleaf’s Dupont says that some reasons are extrinsic to

GPs, which will vary on a case-by-case basis, so one

the manager, such as the macro-environment climate, the

cannot infer too much from these results. As one LP

forecast growth of a certain sector or the existing exposure

remarks: “The reason to pursue a specific investment

of the fund Northleaf is investing in.

is weighted using different factors.”

11

“Others are intrinsic,” he says, “such as the track record, the experience of the team working together and the relationship they want to build with Northleaf to meet our investors’ expectations.

“If you ask me to summarize in one line, it would be a proven ability to generate and sustain excellent returns accretive to our programs over a multi-funds period. Our global platform in private equity, private debt and infrastructure brings a wealth of network and financial means to invest together. It is important to build trust, cooperation and have honest exchanges between both parties.”

Emerging managers still offer attractive returns As investors seek to expand the number of GP relationships, identifying fresh talent — including firsttime fund managers who have spun out of established shops — is a key part of their portfolio differentiation.

Emerging managers, which fall into a broad category but for simplicity, we will refer to as any GP with less than a

Figure 8: In which asset classes will you be favoring emerging managers over the next 12 months?

40% 30% 20% 10% 0% Private Equity

Venture Capital

Hedge Funds

Real Estate

Private Debt

Infrastructure

“Our program is very mature,” comments Helen Lais, managing director, head of primaries U.S., at Capital Dynamics, a leading private markets investor with more than USD 15 billion in AUM. “We’ve been investing in primary funds since the early 1990s. We’re always looking for that next generation of top performers producing returns, sometimes in excess of established managers.”

Quilvest Capital also has a long history of investing in emerging managers, allocating 25 to 30 percent of their primary fund commitments to this category of GP.

three-year track record, are firmly on the radar of LPs

“We are looking at targeted strategies within the mid-

over the next 12 months. In keeping with the survey

market buy-out and growth space with unique angles.

findings, private equity is the most popular asset class

These days, we are particularly interested in themes

to seek out these managers, as cited by 37 percent of

around ‘transformation’ of business models,” notes

respondents. (See Figure 8.)

Jean-Francois Le Ruyet, a partner at Quilvest.

12

The main drivers for backing emerging managers are attractive return potential and the ability to access more niche investment strategies that more established GPs are unable to prosecute because of their size. However, one in five LPs also cited a desire to access new talent. (See Figure 9.)

Figure 9: What is the main driver behind allocating to emerging managers?

“We like emerging managers if they have gone through previous market cycles together; good and bad. We want to see the resilience and the complementary skillsets of the investment team.” ‑ Francois Massut, Peugeot Invest

40% 30% 20%

“We’re not looking to go out of our way to onboard

10% 0%

managers with smaller AUMs, We must have the Attractive return potential

Niche strategy options

Desire to Added More access portfolio likely to new diversification negotiate talent better fees

Lais says that Capital Dynamics prefers niche strategies in certain segments of the market, “such as Healthcare

confidence and conviction they will add value to the portfolio,” they say.

First impressions will count more than ever in this hybrid, post-COVID world of virtual and physical meetings.

Technology and Financial Technology, where we believe

In a sign of just how far the world has changed over the

specialization is needed. This applies to both emerging

last 18 months, when asked whether they would consider

managers and established managers.”

investing in managers they’ve never met, on a purely

Still, the level of competition for attracting assets remains significant. One U.S.-based LP confirms

virtual basis, one-third of LPs replied that they would “on a limited basis.”

that although they’ve started to onboard a couple of

One would never have expected such a response even

emerging managers to complement other parts of their

three years ago. It illustrates the extent to which LPs

portfolio, “the bar is extremely high.”

13

are comfortable using video conferencing and virtual

Indeed, one in five LPs said they would be “happy to do so.”

due diligence to get comfortable with new managers.

(See Figure 10.)

Figure 10: Would you consider investing in a fund manager you’ve never met, in a fully virtual environment, over the next 12 months?

35% 30% 25% 20% 15% 10% 5% 0% Happy to do so

Yes, on a limited basis

Potentially

Probably not

Would never consider it

At Optima, Spindler confirms that they’ve evolved their

forward, we expect to do a combination of both physical

allocation process over the last 18 months given the

and virtual meetings as part of our due diligence process.

travel restrictions, but even though they’ve had to rely on virtual due diligence, the allocations they’ve made have been with managers they had already met in person, prior to the pandemic.

We’ve asked our CCO to establish guidelines and parameters in terms of bringing managers to our offices; the office environment is going to be a little different (concerning health and safety).”

“It was more of a continuation of our due diligence in that respect,” says Spindler. “We’ve started to have some meetings with managers in person and going

14

Transparency, Reporting and ESG As technology innovation and new solutions continue

or “above average”: not exactly terrible, but hardly a ringing

to be embraced by GPs, in a trend that has arguably

endorsement. (See Figure 12.)

been accelerated because of COVID-19, this should help Figure 12: How would you rate the level of transparency provided by managers?

investor relations teams improve the frequency and quality of reporting.

Only 30 percent of LPs felt that better reporting analytics would help improve their relationship with GPs, suggesting that they are broadly satisfied with this aspect.

Nevertheless, there remains a feeling among those surveyed that the level of communication could still be improved upon, as cited by 56 percent. (See Figure 11.)

Figure 11: What would help improve your relationship with GPs?

50% 40% 30% 20% 10% 0% Excellent

Above average

Average

Could do Needs to better significantly improve

Dig more deeply, though, and on an individual LP level, things do seem to be improving. At Northleaf, Dupont explains that

60%

even before the pandemic “we were talking to our partners

50%

on a very regular basis about the portfolios and companies”

40%

and that the COVID-19 situation has further increased

30%

those interactions. “Most managers have been very open

20%

to such exchanges, as the recovery of some companies

10%

has taken some time. Overall, managers were realistic and

0% More frequent conversations with portfolio managers

Better report analytics

Standardized reporting such as ILPA templates

Social media platforms such as LinkedIn

conservative in their valuations.

“The fact that we all have extensively increased the use of videoconferences to reach out to each other allowed [for] more frequent communication.” This sentiment is echoed by

This is further reinforced by the fact that three-quarters

Lais, who notes an improvement in delivery format among

of LPs rate the level of transparency as either “average”

Capital Dynamics’ GPs: “Many of them are hosting quarterly 15

portfolio updates — either through reports or conference calls where we can engage and send in questions in realtime. That has been a really nice improvement. GPs have recognized the importance of staying in touch with LPs.” Setting a standard for transparency Kelly Meldrum, partner and head of primary investments at Adams Street, confirms that many of its GPs started

“We are looking for partnerships and if a GP is not open-minded and willing to share data, we shut the door.” ‑ U.S.-based LP

regular Zoom updates early in the lockdown and “set a standard for transparency.”

She notes that GPs provided frequent updates on portfolio

Understanding the underlying reasons for why some

companies/sectors and over-communicated during a

LPs still feel there is a lack of communication can be

turbulent time: “Our confidence in several general

challenging. Part of it could be down to LPs not willing

partners increased during this period as a result of their

to ask tough questions to a GP and challenge them

information sharing via Zoom and in numerous

on transparency. Peugeot Invest’s Massut is of the view

one-on-one conversations.” Meldrum further adds that

that some GPs play on the division between LPs, i.e., when

Adams Street has seen evidence of more frequent

an investor asks for a change in the LPA and the manager

communication with its general partners over the

says, “You’re the only one asking for this.”

last 18 months. “For example, the number of GP meetings and conversations (excluding annual

“We think LPs need to work more collaboratively to have

meetings) increased 27 percent in 2020 over 2019,”

an alignment of interests not only on the capital they’ve

Meldrum confirms. “While Zoom isn’t a perfect

put to work but on the governance side of the GP/LP

substitute for in-person meetings, it does provide a

relationship. Often there are some conflicts of interest

platform for frequent communication with large as well

within the LPAC. It tends to be led by the biggest investor

as smaller groups of investors.”

in the fund. Often, they are shy and don’t want to ask too many questions because they want to continue to do co-

Some LPs have, however, experienced mixed results

investments with GPs — but when the GP is not present,

with respect to the level of communication, with one

there is a lot more discussion.

investor confirming: “We have seen during COVID-19, GPs who were very transparent on the evolution of their

“So in terms of governance, I think LPAC policies and

underlying portfolio companies and some GPs who did

processes need to improve. It needs to be a comfortable

the minimum amount.”

place for all LPs to ask questions of the GP. 16

We see governance best practices in public equities but

This aspect of the GP/LP relationship would therefore

we don’t yet have that for private equity,” opines Massut.

appear to still need improvement. And while it is hard to

Part of the disconnection on GP/LP communication could, therefore, be down to how LPs approach transparency, on a collective basis.

define exactly what it is that LPs consider as “good enough” technology capabilities, it does suggest that managers who focus on this aspect of their business will likely improve the investment experience.

GPs need to embrace technology

At one leading U.K.-based fund-of-fund manager, the house

Investors are unequivocal in terms of the importance they place on fund managers embracing technology. Not only to raise the bar on transparency but to demonstrate, in more granular detail, how the underlying assets in their portfolios are performing.

view is that GPs’ data capabilities are improving all the time.

“We expect our GPs to focus on and invest in this area, and we are broadly impressed with the ongoing evolution we are seeing,” they say.

As Figure 13 shows, only one in four LPs said they were “very satisfied” with the technology capabilities of the GPs they currently invest with (from a reporting perspective), with the majority — some 69 percent — stating they were only “moderately satisfied.”

Figure 13: How satisfied are you with the technology capabilities of the GPs you currently invest with, in respect of their reporting?

70% 60% 50% 40%

“One of our U.S.-based GPs is increasingly using technology such as digital applications, to accelerate their deal sourcing, execution and value creation. That being said, we still want to see more transparency from managers, especially during the due diligence process (i.e., data on how the carried interest is shared among deal partners, on how profitable the management company is).” ‑ Europe-based LP

30% 20% 10%

“We encourage GPs to embrace technology and share

0% Very satisfied

Moderately satisfied

Not satisfied

underlying portfolio company data,” states Adams Street’s 17

Meldrum. “Reporting and transparency have improved over

This reflects the sheer diversity of strategies and

time. We prefer to have portfolio company information

sophistication of internal operations within the alternative

in order to analyze client portfolios, sector trends,

fund manager space, and the fact that investors prefer

performance by geography and other important factors.”

GPs to use third-party administrators in some instances

Quilvest’s Le Ruyet offers the following balanced view:

more than others. Various factors are likely to play a part

“More technology is obviously nice to have, but on the

in this, including the size of the fund, the complexity of the

LP receiving end this also involves new investment in

investment strategy and the size of the team. Only 15 percent

technology to be able to cope with new communication

of LPs said they had no preference for managers outsourcing

channels, new volumes of data, etc. For now, this is not

back-office functions to an independent fund administrator.

easy to implement, as there is no industry standard.”

This illustrates the extent to which LPs have gotten comfortable with outsourced arrangements, which have

Outsourcing gains prominence

arguably been accelerated as a result of remote-working

One way for GPs to ensure they have the right reporting and technology capabilities in place is to lean on trusted service providers, led principally by fund administrators,

practices over the last 18 months.

ESG insights

many of whom have invested significant resources

This year’s survey respondents were asked to rank how

(financial and human) in automating middle- and back-

important they regarded the following statement on a

office functions. Institutional investors now recognize the

scale of one to five (with one representing the highest level

importance of outsourcing, with 38 percent confirming

of importance): “The quality of ESG data is increasingly

it was their preference, but nearly half (47 percent) of

becoming a central tenet of our ongoing portfolio

respondents feel that it depends on a case-by-case

monitoring process.”

basis. (See Figure 14.)

The average response to this was three, out of five, but again

Figure 14: Do you prefer your fund managers to outsource their back-office functions to a fund administrator?

this is a general finding. On an individual basis, some LPs are more focused on the quality of ESG data than others. It also depends on the geographic location of investors. ESG

50%

has been a focal point of discussion in Europe for several

40%

years now.

30% 20%

“We definitely agree with the above statement, although the

10%

quality of data available, especially from underlying GPs, can

0%

vary. We are working hard to fill in gaps for our own clients Yes

Depends on the manager

No

18

and this is a growing area of focus as a firm, as investor

“Divesting may not be practical,” remarks Alex Lesch, partner,

focus on ESG is intensifying — and broadening — all the

investment strategy and risk management, Adams Street.

time,” comments one European-based allocator.

“We evaluate our managers’ exposure, approach and ESG

LPs are certainly not becoming too overly prescriptive, yet, in assessing the ESG-reporting credentials of fund managers. There is an understanding that, while ESG is an

considerations given their specific ESG risks and concerns to ensure that ESG is integrated across the investment lifecycle, as appropriate to their investments.

increasingly important aspect of understanding portfolio

“There are various levels of reporting and we do not have a

risk, it is a journey that will take time to travel. Investors

one-size-fits-all mindset. This helps inform our underwriting

are not expecting GPs to transform overnight but they

of those managers to ensure we are considering all of the

want to see evidence that ESG risks are being taken

pertinent risks when making investments.”

more seriously.

As a new report by Manulife reveals, 66 percent of LPs see value creation as a leading driver of ESG. Having an ESG policy is one way for GPs to demonstrate their commitment but it is not a dealbreaker. When asked whether they would divest from a manager who was not willing to show an updated ESG policy on an annual basis, only one in 10 LPs were adamant that they would.

(See Figure 15.)

Figure 15: We would divest from a manager if they were not willing to show us their updated ESG policy, on an annual basis.

“Where we would like to see more improvement is on ESG data. The data analytics and quality of data being reported is increasing, and GPs are starting to try and come up with some consistency of reporting going forward. It’s a trend to watch and one we are pleased to see is happening.” ‑ Helen Lais, Capital Dynamics

40% 30% 20% 10% 0% Very high

High

Neutral

Low

Very low

19

Asset Allocation Trends Comparing last year’s survey results to this year’s, the

However, year-over-year, the level of interest for direct

level of interest among investors for co-investment

investments has increased from 23 percent to 31 percent.

opportunities is unchanged, at 33 percent.

(See Figure 16.)

Figure 16: Aside from commingled funds, what will be your preferred investment method over the next 12 months?

35% 30% 25% 20% 15% 10% 5% 0% Fund-of-funds

Funds-of-one

Segregated managed accounts

Direct investment vehicles

Co-investment vehicles

This disintermediation trend is interesting to note.

New York-based Grafine Partners recently wrote on Private

A growing number of LPs are starting to turn away

Equity Wire one example of this is the formation of Capital

from allocating to the largest managers and towards

Constellation, a joint venture founded in 2018 by the Alaska

experienced dealmakers who are starting their own

Permanent Fund Corporation, the Public Institution for Social

shops — many of whom are spinouts from the giant firms.

Security of Kuwait, RPMI Railpen and Wafra.

One of the key drivers behind this is the desire to be

Grafine Partners is a platform that was formed to

directly involved with investments and partner with

address the desire for the most sophisticated institutional

dealmakers outside of a traditional LP fund structure. As

investors to invest directly into operating companies rather

Elizabeth Weymouth, founder and managing partner of

than participating in a traditional blind pool fund. Direct 20

investing is a key part of the Peugeot family’s strategy.

in H1 2021 from USD 10.08 billion in H1 2020. While these

Peugeot Invest manages approximately EUR 6.5 billion,

figures are encouraging, it would seem this year’s survey

of which 60 percent applies to direct investing.

respondents have mixed views on the opportunity set. As

“We do one or two big deals a year, typically between EUR 50 million and EUR 300 million to become long-term partners of company CEOs,” confirms Massut.

This desire for direct investing will doubtless keep GPs on their toes over the coming 12 months. One consequence of the increased competition to put dry powder to work is that valuation multiples will likely remain durable. To placate those LPs who are keen to avoid the typical blind pool fund commitment, managers will need to continue to provide co-investment opportunities.

“When I joined six years ago we had one co-investment,

seen in Figure 17, nearly half of LPs (44 percent) said they would not be increasing their exposure over the next 12 months, while one in three LPs said that they would.

Figure 17: Do you expect to increase your exposure to PE secondaries over the next 12 months?

50% 40% 30% 20% 10% 0% Yes

now we have 23,” states Massut.

“We do on average three to four co-investments a year with our GPs, with other family offices and with dealby-deal platforms. We want exposure to sectors or geographies where we lack capacity or expertise, so most of our co-investments are in the U.S. Our target is to have around 45 to 50 percent exposure to the U.S., 30 to 35

Undecided

No

Among that group, 42 percent confirmed that they would look to increase their allocation to PE secondaries by five to nine percent. (See Figure 18.)

Figure 18: If yes, by how much do you expect to increase your allocation by, within your private equity portfolios?

percent to Europe and the rest to Asia Pacific.”

Mixed sentiment on PE secondaries & buyout valuations

50% 40%

After slumping 27.7 percent in 2020 due to the COVID-19

30%

crisis, the secondary market rebounded to a record

20%

USD 54.9 billion in the first half of 2021 according to

10%

the Setter Capital Volume Report 2021; a 171.7 percent increase from H1 2020. Private equity fund secondaries were up 100.2 percent, increasing to USD 20.18 billion

0% <5%

5-9%

10-19%

>20%

21

One prominent U.K.-based LP says that current

“Ten-year bonds are yielding less than 1.5 percent and

opportunities are weighted to GP-led deals, which

historically this yield has been pretty closely correlated with

surged in the immediate aftermath of the pandemic

the earnings yield of the S&P. The current earnings yield of

as timelines for exits were extended.

the S&P is four to five percent so equities are much more

“We do not see this segment of the market dropping to

attractive than fixed-income securities.

pre-COVID levels any time soon, although we do expect

“To know what will happen to valuations, one has to factor in

the market overall to balance, with a ramp-up of LP-led

what will happen with interest rates. If rates rise materially,

opportunities in the second half of the year, now that

equity valuations should fall which would pose a headwind

there is a clearer view on pricing.

for PE returns. We are underwriting with the expectation of

“We focus on the mid-market and this is an area that is underserved relative to the large-cap space, which can support some attractive deal dynamics,” they say.

higher rates and multiple compression. We are very cautious on investments where leverage and rising multiples are necessary to generate an acceptable underwriting return.”

This mixed sentiment was also evident when LPs were asked for their views on valuation multiples in the buyout space. One in four investors are somewhat optimistic on the buyout space for entry multiples, but one in three investors are cautious.

This is understandable when one considers that deal multiples in the U.S. and European buyout space are at, or close to, record levels. As Bain & Company’s report illustrates, the average EBITDA purchase price multiple for leveraged buyouts in the U.S. last year was 11.4x, while in Europe it climbed sharply to 12.6x.

Jeff Diehl is managing partner & head of investments at Adams Street. He says that while equity valuations (both private and public) are full by historical standards

“Price is important but it will also depend on the underlying growth prospects. Also, does the GP have the capacity to increase the operational value? Managers might buy at 15x and in their models they might expect to exit at the same multiple, or perhaps slightly lower. They can only expect to increase the multiple arbitrage with more EBITDA growth. We therefore look for GPs with big operational teams.” ‑ Francois Massut, Peugeot Invest

when calibrated against interest rates and investible alternatives, they seem quite reasonable:

22

Macro and Sector Outlook Nearly 50 percent of LPs said they will be favoring North

This is understandable given the strength of the U.S.

America, from a regional perspective, when making fresh

market and the sheer depth of the talent pool.

capital commitments to GPs. (See Figure 19.)

Figure 19: Which region will you be favoring over the next 12 months when making capital allocations into alternatives?

“That said, our investors want to continue to invest in Europe and we continue to see good opportunities and strong performance in that part of the market.

“We are not overweighting our North American exposure or

50%

doing anything differently to previous years; we’re staying

40%

consistent with our expected asset allocation that we’ve

30%

agreed to with all of our investors,” explains Lais.

20% 10%

At the sector level, Technology and Healthcare remain the two most germane sectors that LPs want to see their

0% North America

U.K. and Europe

Asia Pacific

Latin America

managers continue to invest in. Collectively, they garnered 55 percent of the survey vote, as one can see in Figure 20.

GPs with the expertise to get deals done in the biggest alternative asset market retain significant appeal.

Figure 20: Which one of the following sectors do you most want to see managers invest in: 50% 40% 30% 20% 10% 0% Technology

Healthcare

Infrastructure

Energy and Power

Real Estate

Consumer Goods and Services

Financial

23

This finding is slightly at odds with the survey’s earlier

2022. Nearly 70 percent of survey respondents either agreed

finding that one in three LPs expressed caution over

or strongly agreed when asked to comment on this, which

market valuations in the buyout space: especially given

should serve as a clarion call to GPs.

that Technology and Healthcare are key drivers of buyout activity.

One sector that is out of vogue with LPs is Energy, which only attracted 10 percent of the vote. “Some managers have included or increased their focus on technology and healthcare, especially in the service sector. On our side, we have a fairly well-balanced portfolio currently, although we have proactively reduced our exposure to the energy sector over recent years,” confirms Dupont.

At bfinance, Goodworth says that their investors are looking to get protection from, rather than profit from, any future volatility.

“At the moment, clients are asking us to identify more market-independent managers; those who may not profit from dislocations, but will equally not be impacted,” he says. “Managers with low net exposure and a multiasset component to their strategy, generating different uncorrelated return streams, are one example. Another

At Capital Dynamics, Lais explains that their approach is

example would be systematic macro and systematic CTAs,

to include a variety of strategies across the middle

which can avoid, rather than capitalize on, disturbances.”

market, noting that “being diversified gives us strong downside protection.”

Themes such as digitization and tech innovation (led by Financial Technology) are likely to feature prominently as

“We’ll have Healthcare, Technology, Consumer Retail,

LPs allocate to alternatives over the coming 12 months,

Industrial and Manufacturing … a whole range of industries

with some investors believing that COVID-19 has accelerated

in our investment products. We don’t tend to overweight

many of the trends that were steadily gaining traction

or underweight any one particular sector. However, one

pre-pandemic.

sector that we did decide to step back from a few years ago was Energy. That has proven to be a great decision, given how much the Energy sector was negatively impacted by COVID-19 last year,” she says.

A positive outlook on alternatives Looking ahead, LPs feel confident that the dislocations caused by the pandemic should create further upside opportunities for alternative investments heading into

“We agree with the majority of survey respondents on this,” says Optima’s Spindler. “To quote Microsoft’s CEO, Satya Nadella, we’ve seen an explosion in e-commerce, in cloud computing, and we think the train has left the station. These trends will continue to accelerate and it should lead to opportunities for hedge fund managers to identify pockets of stress/weakness caused by these trends across different industries and sectors.”

24

Conclusion Alternative fund managers can take confidence from the fact that LPs have been broadly pleased with performance within private markets over the last 12 months. The pandemic has proven to be an important litmus test for GPs to demonstrate their “edge” and this has been borne out by a strong set of annualized returns. So much so that nearly three-quarters of LPs plan on increasing their allocation in 2022, with private equity leading the way as the preferred asset class.

The finding that the majority of LPs surveyed are also choosing to increase the number of GP relationships should also be viewed as a positive among fund managers, with emerging managers remaining a key aspect of how investors will look to diversify their portfolios. Those running niche strategies could fare well with nondirectional hedge funds that can protect investor capital against dislocations, such as multi-strategy, which are figuring high on investment consultant lists.

This year’s survey reveals that LPs still want more transparency from managers. Whether this is a symptom

of LPs themselves not having a common set of expectations on what that level of transparency should be is unclear, but it is something GPs need to be aware of. Anecdotally, it would seem that some investors have been very pleased with the frequency of communication from their GPs during the pandemic, but more needs to be done.

As the survey highlights, only 25 percent were “very satisfied” with the technology capabilities of their GPs. Those who continue to embrace technology to improve the GP/LP relationship could find that they gain a competitive edge.

With ESG risks now becoming an integral part of risk management, this is likely to be the next dominant theme in how LPs assess the quality of reporting and transparency.

The last 12 months have been a defining moment for alternative fund managers. As the investment opportunity set continues to evolve, those managers who embrace technology innovation to enhance the investor experience should be well-positioned to showcase their skill and demonstrate how they are delivering value in their clients’ portfolios. The next 12 months should be compelling.

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