Hamilton Lane’s Jim Strang and MVision's Mounir Guen sat down with Real Deals for a wide-ranging podcast covering everything from how private equity has fared through Covid-19 disruption and LP risk appetite to operational diligence and the what the future holds for single country mid-market funds.

Covid-19 has caused profound disruption across capital markets in 2020, but despite the upheaval private equity has navigated the crisis well. Portfolios have been triaged, liquidity positions strengthened and the transition to homeworking facilitated.

But what comes next for private equity in a post-pandemic world? Real Dealsspoke to private equity mega brain Jim Strang, a managing director at global private markets investor Hamilton Lane and the chair of Hamilton Lane EMEA, and MVision founder Mounir Guen, in an in-depth, hour-long conversation on how the asset class has transformed and what the future holds. Here are some of the highlights:

Investor risk appetite and return expectations

Strang said the goal of any GP was to “keep the lights on until the optimum time to exit the business”, and that given private equity’s control of liquidity decisions, the asset class had an asymmetric risk/return profile. The private equity value proposition was still evolving and the fact that the industry was continuing to grow showed that it was meeting investor risk/return requirements.

“The loss rates in private equity, especially from the larger more established brands, is actually quite a low one,” Strang said. “The golfer Gary Player is a hero of mine and he would always say that in golf, it is not how good you are when you are good, but how good you are when you are bad. For private equity, even when it is bad it is pretty good, which is very helpful.”

Strang added that although there had been some downward pressure on upside returns, there was “a mixed picture” with some GPs continuing to consistently deliver outperformance. The asset class’s improved operational capability and ability to take advantage of multiple expansion had supported ongoing strong risk/ returns.

Guen added that pre-Covid, the investor community was already preparing for the cycle to peak and that there was “a drive to safety”. This saw LPs focus on “consistent returns, regular deployment and principal protection”.

This had moved the needle in favour of bigger private equity franchises, as there was “comfort” that bigger managers could satisfy these criteria. LPs had also expanded their direct investment programmes alongside their primary activity to manage their return outcomes. Again, this played to the strengths of larger managers who had the capacity to offer more co-invest. “The larger funds are able to give more co-invest, so when you package it all together, the market is heading in a direction that favours larger platforms,” Guen said. “The mid-market funds can outperform the mega-funds, but there is volatility in their performance. The question is whether you want to take that volatility in these times or have that safety?”

Operational diligence: as important as returns?

Operational diligence of a manager has become increasingly important for investors, who are paying almost as much attention to the governance, processes, infrastructure and reporting of a manager, as much as the returns track record and investment proposition.

Strang said Hamilton Lane had wholly separate teams to assess operations and investment strategies. An investment team reviewed the investment case and was completely separate from the operational due diligence team. Both teams reported into the investment committee and both had to give an opportunity the green light for an investment to proceed.

“The stakes continue to rise and the bar that is set around standards of governance across multiple dimensions is very high. Most sophisticated investment teams will have some kind of operational due diligence track,” Strang said.

Guen said: “Back in the early 2000s, if you said you did private equity, people gave you money. The flow of capital into the industry was faster than the governance was growing and then a light went off and investors started looking at how GPs ran their businesses. Operational due diligence is still in its early days but if I think about fundraising today, the operational due diligence is now dwarfing the commercial and legal due diligence at the moment.”

Guen added that there still wasn’t a consistency to how operational due diligence was conducted, but that the focus on operations was a positive for the industry overall, despite the additional workload it placed on GPs.

Strang said that benchmarking softer but crucial factors, like leadership, succession and deal attribution across a unique group of firms a was a particular area of interest.

“Data is prevalent and you turn to it because it is comforting, but it doesn’t give you the whole picture because it is all about humans,” Strang said. “You need to have a way to understand that, and relatively rank that to get a sense of what you are getting.”

The next step was to go beyond basing people decisions on gut feel, and improve the depth of interactions between LPs and GPs to reveal insights about teams.

Guen said it was interesting to compare the current market with earlier periods in the market where there wasn’t as much choice and a higher number of first time funds.

“The way that an LP made a commitment was to spend time with a manager. The average fundraise involved ten or 12 meetings… sometimes more,” Guen said. “People spent a lot of time together and both GP and LP could get a feel for the other person.”