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February 2024
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PE Panorama: Industry practices are turning LPs off

private equity
By Paul Mackintosh   
November 27, 2023

According to latest figures from Pitchbook, the European institutional investor base is showing unprecedented resistance to putting more money into private assets. Unprecedented over the past decade, that is.

Data from the the private markets research firm as of November 11 shows European pension funds making just 60 commitments to private markets so far in 2023, just one-third of the 183 commitments made in 2013.

Private equity commitments accounted for the largest share of the total at roughly one-third but that could hardly be called a bonanza. Compared to the recent peak of 292 commitments in 2017, that shows a remarkable loss of appetite. I don’t expect a last-minute Christmas rush.

John Plender, a Financial Times columnist who is also a trustee of the Pearson Group Pension Fund, warns that private equity’s leaders face “a journey from hubris to not-quite-nemesis”, citing the asset class’s increasingly risky and exotic financing tactics to deal with the rising cost of leverage.

The FT also quotes Nick Moakes, chief investment officer of Wellcome Trust, a leading UK institutional investor, describing a “shakeout process” where the “tourist capital” that flowed into the asset class when money was cheap is now exiting, often losing substantially in the process, as institutions realise that they are overexposed to private equity and handicapped by its liquidity. He also criticised the recent practice of net asset value (NAV) borrowing against the value of a fund’s entire portfolio. “The reason these facilities are used is to boost internal rates of return,” he says.

It’s not just limited partners (LPs) that are calling out the problems for the asset class. An opinion piece in the FT by Holden Spaht, a managing partner of Thoma Bravo, a Chicago-based private equity firm with over US$130 billion under management, warns that the rising cost of debt since March 2022 “hasn’t just reshaped the strategic direction of private equity firms - it’s testing the industry’s relationship with risk”.

He also warns against the growing tendency towards whole-portfolio NAV borrowing, which he says can simply be a stop-gap that covers portfolio company underperformance, especially when used to prop up failing investments and “particularly when that is not clearly communicated to the business’s investors”.

NAV loans and the concomitant risk is certainly one issue for LP investors in a fund. Transparency to LPs is quite another. If private equity firms are consistently being opaque to their investors over highly multiplied risk, then no wonder LPs are declining to put money in.