Pensions, endowments, and other institutions are looking to hire help for private equity co- and direct investing. Although direct investments help investors lower their fees, these transactions require new and different skills than institutions traditionally have in-house, according to research from Hamilton Lane.
“Co-investment experience is different from manager selection,” said Mike Koenig, chief client officer, in an interview with Institutional Investor. Most investors are engaging in co-investments, even if there are a number of different approaches, including hiring an external firm to oversee these transactions and buying direct stakes in companies.
“U.S. plans searching for new professionals frequently include co-investing or direct investing as a preference or requirement, and that trend is even more prevalent globally,” writes Koenig, author of a report called “What’s Top of Mind for Today’s LP.”
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Institutional investors are also after more detailed data on portfolio companies from their private equity managers, according to Hamilton Lane. Although investors have been demanding transparency on fees, expenses, and valuations for years, they now want data on underlying companies such as revenue, earnings, and leverage, so they can better understand the entirety of their private markets portfolios. What’s changed is the availability of third-party systems that investors can use to store and manage those data.
“LPs want to look across their entire portfolio on one platform. You need technology vendors to do that,” said Koenig in the interview. He cautioned that “GPs’ willingness to provide information is a work in progress. However, GPs see technology as a way to do this efficiently and in a timely manner, Koenig added.
Investors’ push for more data is also being driven by changes in the private equity markets. As fund raising, and the number of fund managers, investors, and strategies has grown, gains in private equity are largely coming from operational improvements at portfolio companies, according to the report.
“This means that LPs are spending more time focused on GP return attribution, operating partner profiles, and turnover statistics. They are diving deeply into value creation and understanding what specific capabilities a GP has in-house to best position their companies for success,” Koenig wrote.
Hamilton Lane also noted that almost every institutional investor seems to be doing searches for top small- and mid-market funds. Funds with less than $3 billion in assets have historically outperformed large-cap funds. In fact, the alternative investment manager reports that 70 percent of all buyout funds raised in the next 12 months will be on the small side.
The firm says these so-called SMID funds often outperform because general partners have more control than they do with larger companies; smaller deals are also less levered and potentially safer for investors. Hamilton Lane cautioned, however, that these factors —control and leverage— are important, but a deal’s risk or chances for success can’t be predicted by one or two data points.
Hamilton Lane’s data show that small and mid-market funds have beaten the composite of all other private equity strategies in 12 of the last 15 vintage years, but the firm is still advising investors to build diversified portfolios that include venture capital, large-cap and other funds. That’s because, “SMID funds are not uniquely the top performer across vintages — other sectors also offer strong performance,” wrote Koenig.